The Economist regularly publishes the Big Mac index to examine the validity of p

Question

The Economist regularly publishes the Big Mac index to examine the validity of purchasing power parity. If purchasing power parity holds, a consumer should be able to take the same amount of money required to buy a Big Mac in the U.S. and buy a Big Mac in any other country. What are the reasons purchasing power parity may not hold? If the U.S. dollar depreciates against the euro and purchasing power parity holds, would a Big Mac in Europe become more or less expensive? Why? If purchasing power parity doesn

Explanation / Answer

Economic theory linking currency exchange rates to prices paid for goods and services in any two countries. For example, if a basket of goods can be bought with $1,000 in the United States or 150,000 yen in Japan, the parity of the U.S. Dollar to the yen is 1-to-150. If either currency has greater purchasing power, the theory goes, it might be better for buyers to convert yen into dollars, for instance, and buy in the United States. The theory applies to tradable goods with low transportation costs. If the price is different in the two countries, people will not buy in the higher price country.

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