Question: Assume the reference commodity costs 200 US dollars in New York, 360 Australian dollars in Sydney, 120 pounds sterling in London, 800 yuan in Shanghai

Assume the reference commodity costs 200 US dollars in New York, 360 Australian dollars in Sydney, 120 pounds sterling in London, 800 yuan in Shanghai and 22,000 yen in Tokyo.

a. What exchange rates are predicted by the PPP model? List the price of the Australian dollar, British Pound, Chinese Yuan and Japanese Yen, as measured in US dollars.

b. Assume the following current spot exchange rates:

us$0.60 per Australian dollar

us$1.70 per British pound

us$0.20 per Chinese yuan

us$0.01 per Japanese yen

How do these spot rates compare with the PPP predictions? Which currencies are overvalued and which are undervalued, based on PPP theory?

c. Calculate the real exchange rate for each of the above currencies (measured in US dollars).

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