Question

The Economist publishes annually the "hamburger standard" by which they compare the prices of the McDonalds Corporation Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should be the same. A Big Mac costs USD2.54 in the United States and JPY294 in Japan. The current exchange rate is 124 Japanese yen per U.S. dollar.

(a) What is the real exchange rate between the USD and the JPY?
(b) What is the PPP-implied exchange rate as hypothesized by the Hamburger index?
(c) Is the Big Mac hamburger in Japan correctly priced, undervalued or overvalued? By what percentage

Answer 1

The real exchange rate between the USD and the JPY is 477.01 JPY per USD. The PPP-implied exchange rate according to the Hamburger index is approximately 115.75 JPY per USD. The Big Mac hamburger in Japan is overvalued by 311.55% compared to the price in the United States.

Step-by-step explanation:

(a) The real exchange rate between the USD and the JPY can be calculated by dividing the price of the Big Mac in Japan (JPY294) by the price of the Big Mac in the United States (USD2.54) and multiplying it by the market exchange rate (124 JPY per USD). So, the real exchange rate is (294 JPY / 2.54 USD) * (124 JPY / 1 USD) = 477.01 JPY per USD.

(b) The PPP-implied exchange rate as hypothesized by the Hamburger index is based on the assumption that the price of the Big Mac should be the same across the world. So, in this case, the PPP-implied exchange rate would be the price of the Big Mac in Japan (JPY294) divided by the price of the Big Mac in the United States (USD2.54), which is approximately 115.75 JPY per USD.

(c) The Big Mac hamburger in Japan is overvalued compared to the price in the United States. To calculate the percentage overvaluation, we can use the formula:

Percentage overvaluation = ((Real exchange rate - PPP-implied exchange rate) / PPP-implied exchange rate) * 100

So, the percentage overvaluation would be ((477.01 - 115.75) / 115.75) * 100 = 311.55%