Question

A Big Mac is selling for $5 in the US. If the USD/GBP exchange rate is 1.33, how much should the Big Mac sell for in London if Purchasing Power Parity Holds?

1) $3.76
2) 3.76 GBP
3) $6.65
4) 6.65 GBP

Answer 1

If Purchasing Power Parity holds and a Big Mac costs $5 in the US with a USD/GBP exchange rate of 1.33, it should sell for 3.76 GBP in London.

Step-by-step explanation:

The principle of Purchasing Power Parity (PPP) suggests that in the absence of transportation costs and barriers to trade like tariffs, the price of a Big Mac in London should be equivalent to the price of a Big Mac in the US after adjusting for the exchange rate.

Given that a Big Mac is $5 in the US and the current USD/GBP exchange rate is 1.33, we can calculate the price in London by dividing the US price by the exchange rate. This yields 5 / 1.33, which is approximately 3.76. Therefore, under Purchasing Power Parity, the Big Mac should sell for 3.76 GBP in London.

To calculate the price of a Big Mac in London if Purchasing Power Parity (PPP) holds, we need to use the exchange rate to convert the US price to British pounds. The USD/GBP exchange rate is 1.33, meaning that 1 US dollar is equivalent to 1.33 British pounds.

Therefore, if a Big Mac is selling for $5 in the US, we can calculate the price in London by multiplying the US price by the exchange rate: $5 * 1.33 = $6.65 or 6.65 GBP.

So the correct answer would be option 4) 6.65 GBP.