Economics

Solution Preview

The response addresses the queries posted in 1398 words with references.

//The Purchasing Power Parity and the Big Mac Index are the foremost concepts that are fruitful in computing the relative values of the currencies in the countries. Both the theories are very important in terms of global operations. Before starting the paper; it is very essential to provide an introduction of the two theories as it will prove fruitful for comprehending the concepts individually.//

Introduction

The Purchasing Power Parity is that economic theory that undertakes to swap the rates between the countries to represent the purchasing power of each currency. In this way, the Purchasing Power Parity indicates the basket of the basic goods that is supposed to be purchased with the legal tender of the individual country. The theory is grounded upon the law of the one price. This conception indicates that the identical products should be priced on the same grounds in the dissimilar markets (McGuigan, 2009). In addition, the theory of PPP is recognized to persuade only the lasting exchange rates among countries. The theory was propounded by Gustav Cassel in the year 1918.

The concept that is the Big Mac Index is promulgated by the economic expert in an informal way in order to calculate the purchasing power parity amongst the two currencies. After determining the two currencies, it helps in providing the test to the extent to which the market exchange result in the goods that cost the same in the different countries. Basically, the use of this theory is to make the exchange-rate theory more comprehensible. The name given to the index was originated from the Big Mac that is a hamburger traded at McDonald. The theory got initiated in September, 1986 and the founder of this theory was Pam Woodall (Ferrington, 2006).

The outset can be made clearer by this that the Big Mac exchange rate amid the two countries is found by splitting the price of a Big Mac in one country by the price of a Big Mac in another country. This value is further compared with the actual exchange rate. If the exchange rate is determined to be low then the first currency is considered to be devaluated when compared with ...