Economics Dr.

Sauer

The Big Mac Index Fun with Exchange Rates: The Economists Big Mac Index

The index is a lighthearted attempt to gauge how far currencies are from their ________________ value. It is based on the theory of purchasing power parity (PPP). -says that in the _______________ exchange rates should move to equalize the price of an identical basket of goods between two countries Our basket consists of a single item, a Big Mac hamburger, produced in nearly 120 countries. The fair-value benchmark is the exchange rate that leaves burgers costing the _____________________ as elsewhere.

Example: The Czech Republic 1. To calculate the price in US$: Multiply the __________________ by the _________ exchange rate.

If you bought a Big Mac in the Czech Republic, it would cost you 67.6kr . Which means it really costs you __________________. - It is _________ expensive to buy a Big Mac in the US than in the Czech Republic.

2. To calculate the implied PPP of the US$: Divide the ______________________ in the foreign country by the ____________________ in the US.

3. ________________________ the PPP rate to the actual exchange rate to see if the currency is over or undervalued versus the US$. To calculate how much the koruna is under or overvalued by: (PPPrate actual exchange rate) / actual exchange rate x 100

Because the koruna is __________valued vs the dollar, we expect the koruna to _________________ vs the dollar in the future. ____________________________________________________________________________________ Example: Costa Rica 1. Calculate the price in US$:

-It is _____________ expensive to buy a Big Mac in the US than Costa Rica.

2. Calculate the implied PPP of the US$:

3. Check to see if the currency is over or undervalued versus the US$.

Because the colone is _______valued vs the dollar, we expect the colone to ________________ vs the dollar in the future.