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Country Price of a Big Mac Predicted Exchange Rate Actual Exchange Rate Chile 2,640 pesos pesos/$ 679 pesos/$ Hungary 850 forints forints/$ 280 forints/$ Czech Republic 85 korunas korunas/$ 22
Country Price of a Big Mac Predicted Exchange Rate Actual Exchange Rate
Chile 2,640 pesos pesos/$ 679 pesos/$
Hungary 850 forints forints/$ 280 forints/$
Czech Republic 85 korunas korunas/$ 22.3 korunas/$
Brazil 16.9 real real/$ 3.72 real/$
Canada 6.77 C$ C$/$ 1.33 C$/$
1. For each country, compute the predicted exchange rate in terms of the local currency per U.S. dollar. (Recall that the U.S. price of a Big Mac was $5.58 .)
2. According to purchasing-power parity, what is the predicted exchange rate between the Chilean peso and the Canadian dollar? What is the actual exchange rate?
3. How well does the theory of purchasing-power parity explain exchange rates?
Expert Solution
1) Computation of Predicted Exchange Rate:-
The U.S. price of a Big Mac was $4.93
|
Country |
Predicted Exchange Rate |
|
Chile |
2,640 / 4.93 = 535.50 pesos / u.s. dollar |
|
Hungary |
850 / 4.93 = 172.41 forint / u.s. dollar |
|
Czech Republic |
85 / 4.93 = 17.24 korunas / u.s. dollar |
|
Brazil |
16.9 / 4.93 = 3.43 real / u.s. dollar |
|
Canada |
6.77 / 4.93 = 1.37 canadian dollar / u.s. dolllar |
2) According to purchasing-power parity, the predicted exchange rate between the Chilean peso and the Canadian dollar is 389.96 pesos per Canadian dollar. However, the actual exchange rate is 510.53 pesos per Canadian dollar
Actual exchange rate between Chilean Peso & Canada = 510.53 pesos per Canadian dollar. (679 / 1.33)
Predicted exchange rate between Chilean Peso & Canada = 389.96 pesos per Canadian dollar. (2,640 / 6.77)
3) As one can see there is a correlation between the predicted and the actual exchange rate. In general, PPP doesn't hold exactly but it may hold for some goods or it may hold in percent changes (relative PPP) rather than in levels.
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