Question

Suppose a Starbucks tall latte cost $4.00 in the United States, 5.00 euros in the euro area and $2.50 Australian dollars in Australia. Nominal exchange rates are .80 euros per dollar and 1.4 Australian dollars per U.S. dollar. Where does purchasing power parity hold?

a. Both the euro area and Australia


b. Neither the euro area or Australia


c. The euro area butnot Australia


d. Australia but not the euro area.

Answer 1

C. The euro area but not Australia

Step-by-step explanation:

C. The euro area but not Australia

purchasing power parity holds if real exchange rates are equal. While calculating the real exchange rates from the following formula;

Real Exchange Rate = (nominal exchange rate) x (Price of the good X abroad/Price of good X at home

shows that real exchange rate is one for Euro but not for Australia