Question

1.Suppose that a Big Mac costs $5.79 in the US, and CHF 6.5 in Switzerland. You are told that the exchange rate between $ and CHF is CHF=$0.5 From what you know about PPP theory and Law of One Price, the swiss franc is ____________ (undervalued/overvalued/just right)

2.Suppose that a Big Mac costs $5.79 in the US, and CHF 6.5 in Switzerland. You are told that the exchange rate between $ and CHF is CHF=$0.5 From what you know about PPP theory and Law of One Price, the swiss franc in the long run will converge to ________

Answer 1

1) As per the exchange rate 1 CHF = 0.5 dollar or 1 Dollar = 2 CHF.

The price of the Big Mac is $5.9 in the US so in Switzerland, it will be $5.9 x 2 = 11.8 CHF. As per the PPP theory, the cost of Big Mac in Switzerland should be 11.8.

The current price is only 6.5 that means Big Mac is cheaper in Switzerland when compared to the US. The CHF is undervalued. (a currency is considered undervalued when it can buy much lesser goods in other nation at the current exchange price i.e. the Swiss have to pay more for the burger in the US than what they are paying in Switzerland.)

2) The Swiss franc, in the long run, will converge to the "US dollar". ( the Swiss franc has to appreciate against the US dollar. please provide the options to be filled in the blank are they asking about the number i.e. exchange rate, put it in the comment section.)