Question

The Economist magazine uses the price of a Big Mac to determine whether a currency is undervalued or overvalued. In July​ 2017, the price of a Big Mac was​ $5.30 in New​ York, 19.80 yuan in​ Beijing, and 6.50 Swiss francs in Geneva. The exchange rates were 6.79 yuan per U.S. dollar and 0.96 Swiss francs per U.S. dollar.

The price of a Big Mac in different countries​ _______ provide a valid test of purchasing power parity because​ _______.

A.

​does;

local conditions can result in the price of the Big Mac diverging from purchasing power parity

B.

​does;

most people buy Big Macs

C.

does​ not;

purchasing power parity is determined by the price level not by individual prices

D.

does​ not;

a Big Mac has many competitors. A more valid test would be a good that competes in a less competitive market

Answer 1

The cost of making Big Mac is not same in each country.

The local availability of supplies dictates the cost of producing a Big Mac.

Thus, price of Big Mac varies between countries if price of Big Mac is translated into a common currency.

This reflects the difference in purchasing power.

So,

The price of a Big Mac in different countries does provide a valid test of purchasing power parity because local conditions can result in the price of the Big Mac diverging from purchasing power parity.

Hence, the correct answer is the option (A).