Suppose a Starbucks tall latte costs $4.00 in the United States and 3.20 euros in the Euro area.Also,suppose a McDonald's Big Mac costs $4.40 in the United States and 5.50 euros in Euro area.If the nominal exchange rate is .80 euros per dollar,the prices of which goods have prices that are consistent with purchasing-power parity?
A)both the tall latte and the Big Mac
B)the tall latte but not the Big Mac
C)the Big Mac but not the tall latte
D)neither the tall latte nor the Big Mac

Question

Quizplus · Accepted Answer

Purchasing-power parity (PPP) theory suggests that the prices of goods should be equalized across countries when converted to a common currency based on the exchange rate. In this case, we can convert the prices of the Starbucks latte and McDonald's Big Mac from dollars to euros using the exchange rate of 0.80 euros per dollar. If we do this, we find that the Starbucks latte costs 3.20 euros and the Big Mac costs 3.52 euros when converted. Since the price of the latte in the Euro area (3.20 euros) is consistent with the price based on the PPP conversion (also 3.20 euros), choice B is correct. The price of the Big Mac in the Euro area (5.50 euros) is not consistent with the PPP conversion (3.52 euros), so choices A, C, and D are all incorrect.

Suppose a Starbucks Tall Latte Costs $4