Suppose a Starbucks tall latte cost $4.00 in the United States and 3.20 euros in the Euro area. Also, suppose a McDonald's Big Mac costs $3.50 in the United States and 2.45 euros in Euro area. If the nominal exchange rate is .80 euros per dollar, which goods have prices that are consistent with purchasing power parity?
A)Both the tall latte and the Big Mac.
B)Neither the tall latte nor the Big Mac.
C)The tall latte but not the Big Mac.
D)The Big Mac but not the tall latte.

Question

Quizplus · Accepted Answer

To check for purchasing power parity, we need to convert the prices of both goods into the same currency using the exchange rate.

In dollars: 
- Tall Latte = $4.00 
- Big Mac = $3.50

In euros: 
- Tall Latte = 3.20 euros 
- Big Mac = 2.45 euros

Now, we can compare the prices of the two goods. If purchasing power parity holds, then the price of the same good should be the same in different countries when converted to the same currency using the exchange rate.

Using the exchange rate of .80 euros per dollar: 
- The tall latte in euros converts to $4.00 (3.20 euros x 0.80). This is the same price as in the United States, so the tall latte is consistent with purchasing power parity. 
- The Big Mac in euros converts to $1.96 (2.45 euros x 0.80). This is not the same price as in the United States, so the Big Mac is not consistent with purchasing power parity.

Therefore, the correct choice is C) The tall latte but not the Big Mac.

Suppose a Starbucks Tall Latte Cost $4