Question

5. The following table reports the price of a McDonald’s Big Mac for six different countries, with each price denominated in units of the local currency. The table also reports the current-market nominal exchange rate between the United States and the five remaining countries. Country U.S.A. Chile Hungary Czech Republic Brazil Canada Price $3.99 1,800 pesos 700 forints 65 korunas 8.1 real 4.0 C$ Current-market nominal exchange rate -- 552 pesos/$ 200 forints/$ 18.7 korunas/$ 2.2 real/$ 1.2 C$/$ 1 a. Compute the U.S. dollar nominal exchange rate that is implied by the theory of purchasing- power parity (PPP) for each country. Remember, the nominal exchange rate is expressed as units of foreign currency per U.S. dollar. b. For each country, compute the actual real exchange rate measured as the number of foreign Big Mac per U.S. Big Mac. c. According to PPP, what is the predicted nominal exchange rate between the koruna and the Canadian dollar (i.e., koruna per C$)? Based on the data given in the table, what is the actual current-market nominal exchange rate between these two currencies?

Answer 1

We have,

The actual current market nominal exchange rate of USD with five currency. We also have the price of a Big Mac in those countries.

According to PPP, the goods in each country should be sold out at the same price. Thus, the nominal interest rate is based on expected inflation in different countries and the real exchange rate is constant.

Hence, the nominal interest rate of the five currencies with respect to $ based on PPP is as follows.

a

Nominal rate between Peso and USD = Big Mac price in Peso / Big Mac price in $ = 1800/3.99 = 451.13 Peso/$

Similarly,

Nominal rate between forints and $ = 700/3.99 = 175.44 forints/$

Nominal rate between Korunas and $ = 65/3.99 = 16.29 Korunas/$

Nominal rate between real and $ = 8.1/3.99 = 2.03 real/$

Nominal rate between C$ and $ = 4/3.99 = 1.003 C$/$

b

The actual real exchange rate best on number of foreign Big Mac per US Big Mac = Current Market nominal exchange rate / implied exchange rate based on BIg Mac

Hence,

The real exchange rate for Peso = 552/451.13 = 1.22

The real exchange rate for forints = 200/175.44 = 1.14

The real exchange rate for Korunas = 18.7/16.29 = 1.15

The real exchange rate for Peso = 2.2/2.03 = 1.08

The real exchange rate for Peso = 1.2/1.003 = 1.196

c

Predicted Exchange rate between Koruna and C$ based on PPP = (Exchange rate of Koruna / $ based on PPP)* (Exchange rate of $ / C$ based on PPP)

= 16.29 * (1/1.003) = 16.24 Koruna / C$

The actual nominal Exchange rate between Koruna and C$ = 18.7/1.2 = 15.58 Koruna / C$