Question

1) Assume that a Big Mac costs $3.06 in the U.S. and £1.85 in the U.K. Calculate the implied absolute PPP exchange rate $/£. If the actual exchange rate turns out to be $/£ = 1.8519 then show whether the British Pound is overvalued or undervalued relative to the dollar and whether it costs more or less in dollars (pounds) to buy Big Mac in the U.K. (U.S.)

2) Assume that a Big Mac costs $3.25 in the U.S. and 2505 Won in Korea. Calculate the implied absolute PPP exchange rate W/$. If the actual exchange rate is W/$ =820 then show whether or not the Won is undervalued or overvalued relative to the dollar and indicate whether it costs more or less in dollars (won) to purchase Big Mac in Korea (U.S.).

Answer 1

1 Big mac in us- 3.06 $ Big Mac in uk - 1.85$ The implied exchange rate ($1 is derive as price of Big MAC in us pro divided by of Big Mac in uk which is 3.06/1.85= 1.6 The actual exchange rate ($/E) in the man is 1.8519. The implied exchange rate implies for 1 GB pound, You should receive 1.6540 US dollars however you receive 1.8519 dollars. Hence us dollar is undervalued compared to UK pound Alternatively, it costs more in dollars to buy Big Mac in uk 2 Big Mac in us $3.25 Big Mac in Korea - 2505 Won. The implied exchange rate (w/ $) = 2505 /3.25=770.77 The actual exchange rate in the market (w/8)=820 The implied exchange rate implies that for 1 us dollar, you should receive 770.77 won. However you receive 820 won for a dollar. Hence Korea won is undervalued compared to us dollar, Alternatively, it costs more to in Korean won to buy a Big Mac in the us.