Introduction

Purchasing power parity (PPP): Activities

1 Purchasing power parity between South Africa and the USA is measured by the amount of rands which gives the holder the same purchasing power as $1.

Correct. The statement is true.

Purchasing power parity is the number of units of one country’s currency (e.g. rand) which endows the holder with the same purchasing power (i.e. command over goods and services) as one unit of the other country’s currency (e.g. US dollar).

Incorrect. The statement is true.

Purchasing power parity is the number of units of one country’s currency (e.g. rand) which endows the holder with the same purchasing power (i.e. command over goods and services) as one unit of the other country’s currency (e.g. US dollar).

2 A relative PPP exchange rate is similar in many respects to a real exchange rate since the same data is used to calculate both exchange rates.

Correct. The statement is indeed true.

The same information is used.

Incorrect. The statement is true.

The same information is used.

3 A PPP exchange rate can only be expressed as an index.

Incorrect. The statement is false.

A PPP exchange rate can also be expressed as an exchange rate.

Correct. The statement is indeed false.

A PPP exchange rate can also be expressed as an exchange rate.

4 All the conclusions reached on the basis of relative PPPs relate to the situation in the base year of the calculation (in other words, it is assumed that the situation in the base year is somehow normal or correct).

Correct. The statement is indeed true.

The change in relative PPS is measured in terms of the base year and it is assumed that the base year correctly represents the “equilibrium exchange rate”.

Incorrect. The statement is true.

The change in relative PPS is measured in terms of the base year and it is assumed that the base year correctly represents the “equilibrium exchange rate”.

5 By comparing the relative PPP exchange rate with the nominal exchange rate, you can conclude whether the domestic currency is undervalued or overvalued in PPP terms compared to the situation in the base year.

Correct. The statement is indeed true.

If the relative PPP exchange rate for South Africa is 969,88 cents = $1 and the actual exchange rate is 1323,39 cents = $1, you can conclude that the rand is undervalued.

Incorrect. The statement is true.

If the relative PPP exchange rate for South Africa is 969,88 cents = $1 and the actual exchange rate is 1 323,39 cents = $1, you can conclude that the rand is undervalued.

Questions 6 to 8 are based on the following information:

Base year nominal exchange rate (SA cent/$): 730,4
CPI index South Africa: 154,4
CPI index USA: 144,2

6 What is the index value of the two price indices?

Correct. It is 107,1.

It is calculated as follows:

$$
\Bigl(
\frac{
\text{154,4}
} {
\text{144,2}
}
\Bigl)
\times 100
$$

= 107,1

Incorrect. It is 107,1.

It is calculated as follows:

$$
\Bigl(
\frac{
\text{154,4}
} {
\text{144,2}
}
\Bigl)
\times 100
$$

= 107,1

7 What is the purchasing power parity exchange rate (SA cent/US dollar)?

(two decimal places)

Correct. The purchasing power parity exchange rate (SA cent/US dollar) is 782,26.

The calculation is as follows:

$$
\Bigl(
\frac{
\text {Index value of the two price indices} \times {\text {Base year nominal exchange rate}}}
{\text{100}
}
\Bigl)
$$

$$
\Bigl(
\frac{
\text {107,1} \times {\text {730,4}}
} {
\text{100}
}
\Bigl)
$$

= 782,26

Incorrect. The purchasing power parity exchange rate (SA cent/US dollar) is 782,26.
The calculation is as follows:

$$
\Bigl(
\frac{
\text {Index value of the two price indices} \times {\text {Base year nominal exchange rate}}}
{\text{100}
}
\Bigl)
$$

$$
\Bigl(
\frac{
\text {107,1} \times {\text {730,4}}
} {
\text{100}
}
\Bigl)
$$

= 782,26

8 If the actual exchange rate is 1 422,24, is the rand undervalued or overvalued against the US dollar?

Incorrect.

It is undervalued since the purchasing power parity exchange rate is 782,26 and the actual exchange rate is 1 422,24.

Correct.

It is undervalued since the purchasing power parity exchange rate is 782,26 and the actual exchange rate is 1 422,24.

9 An increase in the inflation rate in South Africa relative to the inflation rate in the US will require that the rand must ________ against the dollar to keep the relative purchasing power the same.

Incorrect. The rand/dollar exchange must depreciate.

If the price of goods and services rises faster in South Arica than in the US, the rand needs to depreciate to keep the relative purchasing power parity the same. If this does not happen, it implies that the same goods and services in South Africa are now relatively more expensive.

Correct. The rand/dollar exchange must depreciate.

If the price of goods and services rises faster in South Arica than in the US, the rand needs to depreciate to keep the relative purchasing power parity the same. If this does not happen, it implies that the same goods and services in South Africa are now relatively more expensive.

10 The Big Mac index shows what exchange rates ought to be to equate the domestic price of a Big Mac with its price in other countries.

Correct. The statement is indeed true.

The Big Mac index gives you an indication of the exchange rate that would leave hamburgers costing the same in the US as abroad.

Incorrect. The statement is true.

The Big Mac index gives you an indication of the exchange rate that would leave hamburgers costing the same in the US as abroad.

11 If a Big Mac costs R30,00 in South Africa and $5,28 in the US, then purchasing power parity requires the rand/dollar exchange rate to be R ____ (two decimal places).

(two decimal places)

Correct. To have the same purchasing power parity (be able to purchase a Big Mac at the same price in South Africa or America), the rand/dollar exchange rate needs to be R5,68.

The calculation is as follows:

Price of a Big Mac in rand/Price of a Big Mac in dollars

R30/$5,28
= R5,68

Incorrect. To have the same purchasing power parity (be able to purchase a Big Mac at the same price in South Africa or America), the rand/dollar exchange rate needs to be R5,68.

The calculation is as follows:

Price of a Big Mac in rand/Price of a Big Mac in dollars

R30/$5,28
= R5,68