Question

As of Jan 2012, in Canada a Big Mac costs $4.20. In Turkey it costs 6.5 Lira for the same product. According to the PPP theory, what would you expect the dollar-lira exchange rate (lira/$) to be? If the actual exchange rate was 0.93 (lira/$), does this imply that the Lira is being over or under valued?

Answer 1

Cost of 1 big mac in Lira	6.5
Cost of 1 big mac in Canadian dollars	4.2
4.2 CAD = 6.5 lira
1 CAD = (6.5/4.2) lira
1 CAD = 1.5476 lira
The exchange rate (lira per dollar) is equal to 1.5476.
Actual exchange rate .93 lira/CAD
The exchange rate (lira per dollar) should equal 1.5476 liras per canadian dollar.
However, the actual exchange rate is .93 liras per canadian dollar.
This implies that the lira is being undervalued.