Suppose that the U.S.dollar price of a Big Mac is $3.57.The price of a Big Mac in Norway is 25 kroner.Suppose that the current exchange rate is 5.00 krone per dollar.If absolute PPP holds,the PPP-implied exchange rate is _______ and krone is ________.
A) 5.00 krone per dollar; overvalued.
B) 5.00 krone per dollar; undervalued.
C) 7.00 krone per dollar; overvalued.
D) 7.00 krone per dollar; undervalued.

Question

Quizplus · Accepted Answer

Absolute PPP suggests that the exchange rate should adjust to equalize the prices of identical goods in different countries. In this case, we can use the price of a Big Mac to calculate the PPP-implied exchange rate:

Price of Big Mac in Norway = 25 kroner
Price of Big Mac in the US = $3.57

PPP-implied exchange rate = Price of Big Mac in Norway ÷ Price of Big Mac in the US
= 25 kroner ÷ $3.57
= 7.01 kroner per dollar (rounded to two decimal places)

Since the actual exchange rate is 5.00 kroner per dollar, the Norwegian krone is overvalued according to PPP. Therefore, the correct answer is (C) 7.00 krone per dollar; overvalued.

Suppose That the U