Suppose the average price of a Big Mac in the United States is $3.50 while in Japan the average price is 400 yen. If the market exchange rate is that 1 dollar is exchanged for 100 yen, the purchasing power parity model of exchange rate determination suggests that:
A)the yen is overvalued.
B)the yen value is about correct.
C)the price of a Big Mac in Japan will rise.
D)the dollar will depreciate against the yen.

Question

Quizplus · Accepted Answer

According to the purchasing power parity model, the exchange rate should reflect the relative price levels of two countries. If the average price of a Big Mac in the US is $3.50 and in Japan it is 400 yen, then according to the current exchange rate of 1 dollar for 100 yen, the Big Mac in Japan should cost $4. Therefore, the yen is overvalued and the exchange rate should be adjusted so that the price of a Big Mac in Japan is equivalent to $3.50.

Suppose the Average Price of a Big Mac in the United