Question

Assume that GBP16,541 is the current price level in the United Kingdom, while EUR11,878 is the current price level in France for an equivalent bundle of goods. Given a spot exchange rate of GBP1.0481/EUR, what is the internal and external purchasing power of GBP1.80 million? Is the British pound overvalued or undervalued relative to the Euro?

Select one:

a. 108.82 consumption bundles; 144.59 consumption bundles; overvalued

b. 151.54 consumption bundles; 103.83 consumption bundles; overvalued

c. 103.83 consumption bundles; 151.54 consumption bundles; undervalued

d. 108.82 consumption bundles; 144.59 consumption bundles; undervalued

e. 151.54 consumption bundles; 103.83 consumption bundles; undervalued

Answer 1

GBP1.0481 / EUR = 1

Or

GBP / EUR = 1 / 1.0481 = 0.95

GBP = 0.95 EUR

If you have GBP1.8 million and GBP16,541 is the current price level, you would be able to buy 108.82 units from that.

If you convert GBP1.8 million into EUR using the exchange rate above. As 1 GBP = 0.95 EUR, GBP1.8 million = EUR1.71 million and the price is EUR 11,878. Thus you would be able to buy 144.59 units from that.

From 1British Pound, you are able to get less that 1EUR, you can say that British Pound is strong and overvalued than EUR. Option A is correct.