Purchasing Power Parity Problems
1. In Australia, a Big Mac sells for 4.56 Australian dollars and in U.S., it sells for US$4.07. The current exchange rate is AUD0.92/USD. How much is the Big Mac in Australia overpriced or underpriced? How much is the Australian dollar overvalued or undervalued? (Absolute PPP)
2. You are planning a ski vacation to Mt. Blanc in Chamonix, France, one year from now. You are negotiating over the rental of a chateau. The chateau's owner wishes to preserve his real income against both inflation and exchange rate changes, and so the present weekly rent of €9,800 (Christmas season) will be adjusted upwards or downwards for any change in the French cost of living between now and then. You are basing your budgeting on purchasing power parity (PPP). French inflation is expected to average 3.5% for the coming year, while U.S. dollar inflation is expected to be 2.5%. The current spot rate is $1.3620/€. How much is the euro expected to appreciate or depreciate in one year? What would be the expected rate of euro next year? (Relative PPP)