Question

A Big Mac costs 4.94 Australian dollars in Australia and $4.20 in the U.S. Nominal exchange rate is 2.1 (Australian dollar/US dollar). The PPP exchange rate (fc/$) is --------- and the Australian dollar is ----------------.

1.18; overvalued

1.18; undervalued

0.85; overvalued

2.1; undervalued

Answer 1

The PPP exchange rate based on the price of a Big Mac is 1.18, and when comparing it to the nominal exchange rate of 2.1 AUD/USD, it indicates that the Australian dollar is undervalued.

Step-by-step explanation:

The student is asking about the Purchasing Power Parity (PPP) exchange rate and whether the Australian dollar is overvalued or undervalued against the U.S. dollar based on the price of a Big Mac in both countries. To calculate the PPP exchange rate, we divide the price of a Big Mac in Australia ($4.94 AUD) by the price of a Big Mac in the U.S. ($4.20 USD).

This gives us a PPP rate of 1.18 (4.94/4.20). Now, we need to compare this PPP rate to the nominal exchange rate, which is 2.1 AUD/USD. Since the PPP rate is less than the nominal rate, this means that the Australian dollar is undervalued when compared to the U.S. dollar. If the Australian dollar were appropriately valued, it would cost less in Australian dollar terms to buy a Big Mac in Australia than it currently does when compared to the U.S. price.