Question

8. Purchasing-power parity 

Using data from The Economist's Big Mac Index for 2016, the following table shows the local currency price of a Big Mac in several countries as well as the actual exchange rate between each country and the United States. At the time of the data collection, a Big Mac would have cost you $4.93 in the United States and GBP 2.89 in the United Kingdom. The actual exchange rate between the British pound and the U.S. dollar was $1.63 per pound. The dollar price of a Big Mac purchased in the United Kingdom was, therefore, computed as follows: 

Dollar price of a Big Mac in the United Kingdom = GBP 2.89 x = $4.71

 For the price you paid for a Big Mac in the United States, you could have purchased a Big Mac in the United Kingdom and had some change left over for fries! 

Complete the final column of the table by computing the dollar price of a Big Mac for the countries where this amount is not given.

 Note: Round your answers to the nearest cent. 

Dollar Price (Dollars) Brazil Norway United Kingdom Poland Local Price (Foreign currency) 13.50 46.80 2.89 9.60 17.60 Big Mac Index: January 2016 Actual Exchange Rate Actual Fychan (Dollars per unit of foreign currency) 0.30 0.12 1.63 0.36 0.16 4.71 3.46 2.82 China 

Purchasing-power parity (PPP) theory states that exchange rates would need to equalize the prices of goods in any two countries. For the dollar price of a Big Mac to be the same in both countries, a U.S. citizen would need to be able to convert $4.93 into exactly GBP 2.89. To find the exchange rate at which hamburger purchasing power is the same in both countries, divide the price in the United States by the price in the United Kingdom: 

PPP Exchange Rate (U.S. Dollars per British pound) = .95 = $1.71 per pound 

The exchange rate that would have equalized the dollar price of a Big Mac in the United States and Brazil (that is, the PPP exchange rate for Big Macs) This change would mean that the real had against the dollar. 

If Big Macs were a durable good that could be costlessly transported between countries, which of the following would present an arbitrage opportunity? Check all that apply. 

Exporting Big Macs from Norway to China 

Exporting Big Macs from Brazil to the United States 

Exporting Big Macs from Poland to China

Answer 1

	Local Price (Foreign Currency)	Actual Exchange Rate ($ per foreign currency)	Dollar Price ($)
Brazil	13.50	0.30	4.05
Norway	46.80	0.12	5.62
United Kingdom	2.89	1.63	4.71
Poland	9.60	0.36	3.46
China	17.60	0.16	2.82

Part 1:

Dollar Price of Big Mac in Brazil = 13.50 x $0.30/1.00 = $4.05

Dollar Price of Big Mac in Norway = 46.80 x $0.12/1.00 = $5.62

Part 2:

Given,

Dollar price of Big Mac in the United States = $4.93

According to PPP theory, the exchange rate between the US and the Brazil currencies = $4.93/13.50 = $0.365 per Brazil currency

Therefore, the Brazilian currency(real) would now get you more $. Therefore, the real (Brazilian currency) had appreciated against the dollar

Part 3:

Option 1 -

The dollar price of Big Mac in Norway($5.62) is higher than that in China($2.82). Therefore, exporting Big Mac from Norway to China would result in a loss as the relative prices in China are lower than Norway. No arbitrage opportunity.

Option 2 -

The dollar price of Big Mac in Brazil($4.05) is lower than that in the United States($4.93). Therefore, exporting Big Mac from Brazil to the U.S. is profitable. There is an arbitrage opportunity.

Option 3 -

The dollar price of Big Mac in Poland($3.46) is higher than that in China($2.82). Therefore, exporting Big Mac from Poland to China would result in a loss as the relative prices in China are lower than Poland. No arbitrage opportunity

Ans: Option 2 only