Question

A Big Mac costs $5.25 in the United States, 32.55 pesos in Country X, and 53.55 rupees in Country Y.

a. The implied exchange rate for Country X is  pesos per dollar.

b. The implied exchange rate for Country Y is  rupees per dollar.

Suppose the official exchange rates are 9.4 pesos per dollar and 8.6 rupees per dollar. Based on this information:

c. the prices of goods in Country X are  %   (type the word higher or lower) than the U.S.

d. the prices of goods in Country y are  %   (type the word higher or lower) than the U.S.

e. Suppose real per capita income in the U.S. is $52,000, in Country X it is 200,000 pesos, and in Country Y it is 300,000 rupees.  

Round these to the nearest whole number.

PPP adjusted real per capita income in country X is $  .

PPP adjusted real per capita income in country Y is $  .

Answer 1

Cost of Big Mac:

US= $5.25, Country X= 32.55 pesos, Country Y= 53.55

a) The implied exchange rate is the rate that equalises the price of Big Mac in both the countries. It is also called the purchasing power parity (PPP).

The implied exchange rate for country X:

Implied exchange rate= 32.55/5.25= 6.2 pesos per dollar

b) The implied exchange rate for Country Y:

Implied exchange rate= 53.55/5.25= 10.2 rupees per dollar

c) Official exchange rate of country X= 9.4 pesos per dollar

Implied exchange rate of country X= 6.2 pesos per dollar

If the official exchange rate is higher than the implied exchange rate, the currency is under-valued.

The pesos was under-valued by 34.04%. [ (6.2-9.4/ 9.4)x 100= (-3.2/9.4)x100]

The prices of goods in Country X are 34% lower than the U.S.

d) Official exchange rate of country Y= 8.6 rupees per dollar

Implied exchange rate of country Y= 10.2 rupees per dollar

If the implied exchange rate is higher than the official exchange rate, the currency is over-valued.

The rupees is over-valued by 18.6% [(10.2-8.6/8.6)x100= (1.6/8.6)x100]

The prices of goods in Country Y are 18.6% higher than the U.S.

e) PPP adjusted real per capita income in country X is $ 32,258. [ 2000,000 pesos/ 6.2 pesos per dollar]

PPP adjusted real per capita income in country Y is $ 29,412. [ 300,000 rupees/ 10.2 rupees per dollar]