Answer to Question #127356 in Macroeconomics for yuhanis

Question

The NEWS magazine uses the price of a Mercedes Benz A-class to determine whether a currency
is undervalued or overvalued. In July 2019, the price of Mercedes Benz was $55 thousand in New
York, 390 thousand yuan in Beijing, and 66.5 thousand Swiss francs in Geneva. The exchanges
rates were 6.79 yuan per U.S. dollar and 0.96 Swiss francs per U.S. dollar.

a. Does the purchasing power parity hold? Was yuan undervalued or overvalued relative US
dollar? Explain your answer and show the calculation.
(2 marks)
b. Do you think the price of a representativeness car, Mercedes Benz in different countries
provides a valid test of purchasing power parity?
(2 marks)

Answer 1

a)     Purchasing Power Parity is a situation of comparing different countries’ currencies using the basket of goods approach. Besides, it helps in undertaking a comparison of the living standards and the productivity of different types of economies.

b)     No, because in this scenario the Purchasing Power Parity does not here. The parity price for the same good as in this case Mercedes Benz A-class, is not the same. Therefore, for Purchasing Power Parity to apply, the purchasing power of a unity of currency, should be equal both in the domestic and foreign economy after it has been converted into foreign currency using the prevailing market exchange rate.