Question

4. A Big Mac costs 190 rupees in India and $5.75 in the United States. If you use the Big Mac as a “basket” to measure the price level in a country, what should the $ / rupee rate be? If the actual rate is $ 0.015 / rupee , then is the rupee over or under valued? What is real exchange rate in US Big Macs per Indian Big Macs? (If you took a Big Mac in India, sold it for rupees, turned the proceeds into dollars and then bought Big Macs in the U.S., how much of a Big Mac would you have….)

Answer 1

Ans.
a) Exchange rate = Price of the burger in USA / Price of the burger in India = 5.75/190 = $0.030263/Rupee

b) The market exchange rate is $0.015/Rupee, but for exchange rate from relative price of baskets n the two countries is $0.030263/Rupee which means that the rupee is undervalued.

c) Exchange rate, e = $0.015/Rupee

Price of the burger in USA, P1 = $5.75

Price of the burger in India, P2 = ₹190

=> Real exchange rate, R = e*P2/P1

=> R = 0.015*190/5.75 = 0.495

Thus, real exchange rate is 0.495.

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