Official exchange rates between the US dollar and three other currencies are giv
ID: 1115905 • Letter: O
Question
Official exchange rates between the US dollar and three other currencies are given below. You are also given the following information about the cost of the same basket of goods in the US, Europe, Brazil and Singapore. Calculate the purchasing power parity rates for the dollar against the other currencies. Then state whether the US dollar is overvalued or undervalued against the Euro, BRL and SGD. (3)
Official Exchange Rates:
$1= 0.90 euro
$1= 3.13 Brazilian real (BRL)
$1= 1.39 Singapore dollar (SGD)
US
Europe
Brazil
Singapore
Milk
$4
6 Euros
7 BRL
4 SGD
Bread
$5
3 Euros
4 BRL
3 SGD
Cheese
$7
6 Euros
6 BRL
4 SGD
Egg
$4
4 Euros
5 BRL
5 SGD
a. Britain’s income increases.
b. Britain’s price level declines relative to the U.S. price level.
c. Britain’s interest rates decline relative to U.S. interest rates.
US
Europe
Brazil
Singapore
Milk
$4
6 Euros
7 BRL
4 SGD
Bread
$5
3 Euros
4 BRL
3 SGD
Cheese
$7
6 Euros
6 BRL
4 SGD
Egg
$4
4 Euros
5 BRL
5 SGD
Explanation / Answer
Purchasing Power Parity = P1/P2
where P1 is Price in one country
P2 is price of the same commodity in other country.
Official Exchange Rate of Euro against 1 Dollar = 0.9
Average of all basket of Goods = 1.5 + 0.6 + .86 + 1= .9
As, PPP is same to exchange rate, so there is Purchasing Power Parity.
Official Exchange Rate of Brazilian Real against 1 Dollar = 3.13
Average of all basket of goods = 1.75 + 0.8+ .86 + 1.25 = 1.17
As Exchange Rate is higher than PPP, so US $ is overvalued.
Official Exchange Rate of Singapore Dollar against 1Dollar = 1.39
Average of all basket of goods = 1 + 0.6 + .57 + 1.25 = .86
As the Exchange Rate is higher than PPP, so US $ is overvalued.
US Europe Brazil Singapore PPP between Europe and US PPP between Brazil and US PPP between Singapore and US Milk 4 6 7 4 6/4 = 1.5 7/4 = 1.75 4/4 = 1 Bread 5 3 4 3 3/5 = 0.6 4/5 = 0.8 3/5 = 0.6 Cheese 7 6 6 4 6/7 = .86 6/7 = .86 4/7 = .57 Egg 4 4 5 5 4/4 = 1 5/4 = 1.25 5/4 = 1.25Related Questions
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