Question

Pakistan’s GDP in 2010, using the official exchange rate on 1/1/2010, is equal to $300 billion USD ($300,000,000,000). When the same GDP is converted to dollars using the PPP-implied exchange rate on 1/1/2010, the USD value of the GDP increases to $500 billion ($500,000,000,000). On 1/1/2010, is the Pakistani Rupee overvalued or undervalued against the USD? Explain your answer.

Answer 1

Ans)   we can see that ,

As per official exchange rate

Pakistani GDP = $300 billion

As per PPP exchange rate,

Pakistani GDP = $500 billion

This implies that the Pakistani rupee is undervalued against the dollar.In other words, a particular item costs less in Pakistan when converted in US dollars.

To explain the above context, we use one example:

Suppose there are 2 countries - US and Mexico , each having "Dollar" and "Pesos" as their official currencies.

Let the PPP exchange rate be 1$/30 Pesos, so that an item costs exactly same in both the countries. Now, suppose that the current spot exchange rate is $1/15 Pesos.

So, if an item costs 30 Pesos in Mexico, that same item costs 15 Pesos in united states (when dollar is converted in Pesos as per the current official exchange rate) which sows that the US dollar is undervalued.