In: Economics
think of another good (or service) that is relatively similar in several parts of the world, find the prices of this good or service, determine the relative exchange rates (in terms of the number of units of the foreign good per one unit of the domestic good), and state whether this implies that the foreign currency is undervalued or overvalued. In your answer, please include the links to the prices
solution:
Lets say if BigMac Which is commonly found in Germany and USA, where cost of a Bigmac is 1.36 $ in usa and 1 euro in germany. so for US holder it costs him 1.36$ to buy 1Euro and hence from euro holder perspective the nominal exchange rate will be 1/1.36= 0.735.
Hence for euro perspective nominal exchange rate= 0.735 dollar
for US holder perspective nominal exchange rate= 1.36 euro
the relative exchange rate between two countries is given by product of nominal exchange rate and ratio of prices between two countries.
Now lets bigmac costs 3 euros in germany and 3.4 $ in usa.
then relative exchange rate= 1.36 euro *3euro /3.4 dollar =1.2 euro/dollar
This means when relative exchange rate is 1.2 euros/dollar which means it costs 20% more in euro area, which infers that in relative exchange terms the euro is 20% overvalued relative to dollar.
above rates have been taken from numbeo and expatisan website for reference.