Question

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: 

$$ \begin{array}{l} \text { Dollar price of a Big Mac in the United Kingdom }=\text { GBP } 2.89 \times \frac{\$ 1.63}{\text { GBP } 1.00}\\ =\$ 4.71 \end{array} $$

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.  

Source: "Currency Comparison, To Go, " The Economist, last modified January 7, 2016, accessed July 8, 2016, http://www.economist.com/blogs/graphicdetail/2016/01/daily-chart- 

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) = $4.93/GBP 2.89  = $1.71 per pound  

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

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

Exporting Big Macs from the Eurozone to the United States  

Exporting Big Macs from Poland to China  

Exporting Big Macs from Switzerland to China

Answer 1

a)

The Eurozone dollar price can calculated as, Dollar price \(=\) Local price \(\times\) Actual exchange rate \(=3.72 \times 1.10\)

\(=4.092\)

Therefoer, the Eurozone exchange rate doll ar price is \(\$ 4.1\)

The Switzerland doll ar price can be calculated as, Dollar price \(=\) Local price \(\times\) Actual exchange rate \(=6.50 \times 1.02\)

\(=6.63\)

Therefore the switzerl and exchange rate dollar price is \(\$ 6.63\)

b)

The exchange rate that would have equalized the dollar price of a Big Mac in the United States and the Eurozone is \(\$ 4.93 / \$ 3.72=\$ 1.32\).

This change would mean that the euro had appreciated against the dollar.

c)

Exporting Big Macs from the Eurozone to the United States, the arbitrage is possible because the foreign dollar price is relatively low in the Eurozone to the United States, so there is arbitrage opportunity.

Exporting big macs from Poland to china, the arbitrage opportunity is not possible because the dollar price level is high.

Exporting big macs from Switzerland to china, there is no arbitrage opportunity between the countries is not possible, because of the dollar price is relatively high.