4. The Big Max index
Using data from The Economist’s Big Mac Index for 2016, the following table shows the local currency price of a Big Mac hamburger 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 KingdomDollar Price of a Big Mac in the United Kingdom | = = | GBP 2.89×$1.63GBP 1.00GBP 2.89×$1.63GBP 1.00 |
| = = | $4.71$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 to go toward 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.)
|
Foreign Currency
|
Big Mac Index: January 2016
|
|||
|---|---|---|---|---|
|
Local Price
|
Actual Exchange Rate
|
Dollar Price
|
||
|
(Foreign currency)
|
(Dollars per unit of foreign currency)
|
(Dollars)
|
||
| The Eurozone | Euro | 3.72 | 1.10 |
4.09
|
| Switzerland | Franc | 6.50 | 1.02 |
6.63
|
| United Kingdom | Pound | 2.89 | 1.63 | 4.71 |
| Poland | Zloty | 9.60 | 0.36 | 3.46 |
| China | Yuan | 17.60 | 0.16 | 2.82 |
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-7.
Points:
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Close Explanation
Explanation:
To find the dollar price of a Big Mac in the Eurozone, multiply the local currency price by the exchange rate:
| Dollar Price of a Big Mac in the EurozoneDollar Price of a Big Mac in the Eurozone | = = | EUR 3.72×$1.10EUR 1.00EUR 3.72×$1.10EUR 1.00 |
| = = | $4.09$4.09 |
Similar calculations can be performed for Switzerland:
| Dollar Price of a Big Mac in SwitzerlandDollar Price of a Big Mac in Switzerland | = = | CHF 6.50×$1.02CHF 1.00CHF 6.50×$1.02CHF 1.00 |
| = = | $6.63$6.63 |
The law of one price 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:
| Law of One Price Exchange Rate (U.S. Dollars per British Pound)Law of One Price Exchange Rate (U.S. Dollars per British Pound) | = = | $4.93GBP 2.89$4.93GBP 2.89 |
| = = | $1.71 per British pound$1.71 per British 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 law of one price exchange rate for Big Macs) is![]()
$1.33 per euro 
. For this change to happen, the euro would have to![]()
appreciate against the dollar.
. For this change to happen, the euro would have to against the dollar.Points:
1 / 1
Close Explanation
Explanation:
For the dollar price of a Big Mac to be the same in the United States and the Eurozone, a U.S. citizen would need to be able to convert $4.93 into exactly EUR 3.72. 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 Eurozone:
| Law of One Price Exchange Rate (U.S. Dollars perEuro)Law of One Price Exchange Rate (U.S. Dollars perEuro) | = = | $4.93EUR 3.72$4.93EUR 3.72 |
| = = | $1.33 per euro$1.33 per euro |
If the exchange rate had risen from $1.10 to $1.33, the euro would have to appreciate relative to the dollar because it would require more dollars to purchase a single euro. At this exchange rate, the dollar price of a Big Mac in the Eurozone would have been $4.93 (equal to the dollar price of a Big Mac in the United States); therefore, this is the law of one price rate.
If Big Macs were a durable good that could be transported between countries at no cost, which of the following would present arbitrage opportunities? Check all that apply.
Points:
1 / 1
Close Explanation
Explanation:
Arbitrage opportunities exist where a good can be bought in one country at a low price and sold in another at a higher price. Because Big Macs are cheaper in the Eurozone than in the United States, this would present such an opportunity.
In reality, the law of one price doesn’t apply perfectly to nondurable goods such as hamburgers. Because they would spoil, people don’t buy Big Macs in one country and sell them in another.
