Describe in words (be brief) the central idea behind the calculation of a Purchasing Power Parity (PPP) exchange rate.

At the end of Chapter 13 (page 285-86) you are introduced to the “Big Mac” Index (a purchasing power parity exchange rate calculation between the dollar and many world currencies). In this week’s Content section, you will find a brief article from The Economist Magazineregarding current values for the Big Mac Index. You may also find the Wikipedia entry for the HYPERLINK “http://en.wikipedia.org/wiki/Big_Mac_Index” Big Mac Index to be of interest.

For this week’s assignment:

1. Describe in words (be brief) the central idea behind the calculation of a Purchasing Power Parity (PPP) exchange rate. Put another way, if we have the actual rate at which two currencies exchange for each other, why bother with the PPP version?

2. Using the data in the January 24, 2015Economist article (See: “The Big Mac Index: Oily and Easy” in this week’s Content page) show how the Economist arrived at the conclusion that the Chinese Yuan (Renminbi) is approximately 42% under valued with respect to the US dollar. [Hint: If the dollar price of a Big Mac is higher in another country than it is in the U.S., then we say that the currency is over-valued with respect to the dollar (and vice versa). Calculating the degree of over or under value is just calculating the percentage over or under price (of the Big Mac) with respect to the base dollar price (of the Big Mac).]

3. From the vantage point of China, is an under-valued currency a good thing? Explain.

[Remember that an under-valued valued currency makes imports more expensive and exports less expensive.]

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