MakingThe Big Mac Theoryof Exchange RatestheConnectionNo es un suenoThe Economist magazine collectsthehecho realidad.Sontres.prices of Big Macs in different countries.In July 2011, the average price of a BigMac was $4.56 in the United States.Comparing this to the average prices ofBig Macs in other countries offers a(light-hearted)testofpurchasingpowerparity:COUNTRYBIGMACPRICEIMPLIEDEXCHANGERATEACTUALEXCHANGERATEMexico37pesos8.11pesosperdollar12.94pesosperdollar320 yenJapan70.18 yen per dollar100.11yenperdollarUnitedKingdom2.69pounds0.59poundperdollar0.67 pound perdollarSwitzerland6.5Swissfrancs1.43Swissfrancsperdollar0.97SwissfrancsperdollarIndonesia27,939rupiahs6,127rupiahsperdollar9,965rupiahsperdollarCanada5.53Canadiandollars1.05Canadiandollars1.21CanadiandollarsperU.S.dollarperU.S.dollarChina16 yuan3.51yuanperdollar6.13yuanperdollar112015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 11 Making the Connection The Big Mac Theory of Exchange Rates The Economist magazine collects the prices of Big Macs in different countries. In July 2011, the average price of a Big Mac was $4.56 in the United States. Comparing this to the average prices of Big Macs in other countries offers a (light-hearted) test of purchasing power parity: COUNTRY BIG MAC PRICE IMPLIED EXCHANGE RATE ACTUAL EXCHANGE RATE Mexico 37 pesos 8.11 pesos per dollar 12.94 pesos per dollar Japan 320 yen 70.18 yen per dollar 100.11 yen per dollar United Kingdom 2.69 pounds 0.59 pound per dollar 0.67 pound per dollar Switzerland 6.5 Swiss francs 1.43 Swiss francs per dollar 0.97 Swiss francs per dollar Indonesia 27,939 rupiahs 6,127 rupiahs per dollar 9,965 rupiahs per dollar Canada 5.53 Canadian dollars 1.21 Canadian dollars per U.S. dollar 1.05 Canadian dollars per U.S. dollar China 16 yuan 3.51 yuan per dollar 6.13 yuan per dollar
Determinants of Exchange Rates inthe LongRun-part 1RelativepricelevelsPurchasing power parity explains some exchange rate movements.Example:PricesinJapanhaverisenslowerthanpricesintheU.S.,helpingto explain whythe Japaneseyenhas appreciated invaluerelative to the U.S. dollar.Relative rates of productivity growthA country with relatively high productivity growth will have lessexpensive products; demand for these products from foreigners willcausethedomestic currencytoappreciateExample: Japanese productivity rose faster than U.S productivity inthe 1970s and 1980s, contributing to the depreciation of the U.Sdollaroverthattime122015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 12 Determinants of Exchange Rates in the Long Run—part 1 Relative price levels Purchasing power parity explains some exchange rate movements. Example: Prices in Japan have risen slower than prices in the U.S., helping to explain why the Japanese yen has appreciated in value relative to the U.S. dollar. Relative rates of productivity growth A country with relatively high productivity growth will have less expensive products; demand for these products from foreigners will cause the domestic currency to appreciate Example: Japanese productivity rose faster than U.S productivity in the 1970s and 1980s, contributing to the depreciation of the U.S. dollar over that time
Determinants of Exchange Rates inthe Long Runpart2Preferences fordomestic andforeigngoodsIf consumers in Canada increase their demand for U.S. goods, theyincrease their demand for U.S. dollars, and hence appreciate thevalueof the sUS.TariffsandquotasHightariffs or restrictive quotas reduce the demand for foreign goodsand hence cause the domestic currency to appreciate.@2015PearsonEducation,Inc.13
© 2015 Pearson Education, Inc. 13 Determinants of Exchange Rates in the Long Run—part 2 Preferences for domestic and foreign goods If consumers in Canada increase their demand for U.S. goods, they increase their demand for U.S. dollars, and hence appreciate the value of the $US. Tariffs and quotas High tariffs or restrictive quotas reduce the demand for foreign goods, and hence cause the domestic currency to appreciate
HowDo Exchange Rates AffectFirms?An appreciation of the U.S. dollar makes imports cheaper for us tobuy but makes our exports more expensive forforeigners.. So importing firms tend to like it when the $US is valued morehighly, and exporting firms tend to prefer it when the $Us isrelativelyweaker.But floating exchange rates also add an element of risk to foreigntransactions, making it difficult for firms to make long-term plansinvolvingforeigntrade· Markets do exist for buying future currency at current prices, butfirms pay a premium for this risk-reduction.@2015PearsonEducation,Inc.14
© 2015 Pearson Education, Inc. 14 How Do Exchange Rates Affect Firms? An appreciation of the U.S. dollar makes imports cheaper for us to buy but makes our exports more expensive for foreigners. • So importing firms tend to like it when the $US is valued more highly, and exporting firms tend to prefer it when the $US is relatively weaker. But floating exchange rates also add an element of risk to foreign transactions, making it difficult for firms to make long-term plans involving foreign trade. • Markets do exist for buying future currency at current prices, but firms pay a premium for this risk-reduction