Question

Use the below table to answer the following questions: (Please show all calculations and formulas)

Country	Exchange rate per dollar	Price in local currency
South Africa (rand)	8	3,500
Brazil (real)	2.2	1,200
India (rupee)	45	18,000
Mexico (peso)	10	6,000

1. Suppose a computer costs $500 in the United States. Looking at the actual prices, does the PPP hold between U.S. and Brazil? If PPP were to hold at the nominal exchange rate provided, what would be the price of a computer in Brazil?

2. Suppose a computer costs $500 in the United States. With the price of the computer given in local currency in India, is the Indian rupee overvalued or undervalued? By how much (in percent)?

Answer 1

(a) Price of Computer in US = 500 USD, as per PPP its price in Brazil = 500*2.2 = 1100. Actual Price= 1200
Hence, PPP doesn't hold. If it were to hold, price would have been 1200

(b) Price in India = 18000, If PPP were to hold, price in US would be = 18000/45 = 400. Actual price= 500
Here too, PPP doesn't hold.
PPP exchange rate would be: Price in India/ Price in US = 18000/500 = 36.

Therefore, PPP exchange rate is lesser than actual ER, i.e. actual value of currency is lesser than what it would be as per PPP, hence the currency is UNDERVALUED