Suppose that the U.S.dollar price of a Big Mac is $3.57.The price of a Big Mac in China is 12.5 yuan.Suppose that the current exchange rate is 6.83 yuan per dollar.If absolute PPP holds,the PPP-implied exchange rate is _______ and yuan is ________.
A) 3.50 yuan per dollar; overvalued.
B) 3.50 yuan per dollar; undervalued.
C) 1.83 yuan per dollar; overvalued.
D) 1.83 yuan per dollar; undervalued.

Question

Quizplus · Accepted Answer

The PPP-implied exchange rate can be calculated by the ratio of prices of the same good in two countries:

PPP-implied exchange rate = Price in China / Price in US = 12.5 yuan / $3.57 = 3.50 yuan per dollar

The current exchange rate is 6.83 yuan per dollar, which means that the yuan is undervalued relative to the PPP-implied exchange rate. Therefore, we choose option B, which indicates an undervalued yuan.

Suppose That the U