Exchange rate
The value of one currency in terms of
another currency
Exchange rates
How many Australian dollars could you buy
with US$ 1.00?
1.00 USD = 1.25 AUD
How many US dollars could you buy with
A$1?
1 AUD = 0.80 USD
Live rates at 10/01/2008
Exchange rate – converting prices
To convert a price in foreign currency into
US$
Price US$ = Price in local currency/exchange rate
for US$1
Example:
1 bottle Australian wine costs A$15
Exchange rate is US$1 = A$1.25
Price US$ = A$15/1.25 = US$12
Changes in the exchange rate
Depreciation of US$
Old New
Price A$ Ex. Rate Price US$ Ex. Rate Price US$
15 1.25 12 1.2 12.5
Appreciation of US$
Old New
Price A$ Ex. Rate Price US$ Ex. Rate Price US$
15 1.25 12 1.5 10
Winners and losers with changes in
exchange rates
Fluctuating value of US$ v. Euro
United States Dollar per Euro, (EUR=X)
Monthly prices from 11-Feb-2003 to 11-Feb-2008
Purchasing Power Parity
When market exchange rate reflects price-
level differences between the countries
Big Mac Price Index – if exchange rates
perfectly reflect purchasing power parity then
the price of a Big Mac should be the same in
each country.
Market rates however rarely reflect
purchasing power
Undervalued currency
Market conditions
Average price of a Big Mac in Argentina = 4.13
pesos
Market exchange rate is US$1 = 3.50 pesos
Average price of a Big Mac in the US = $2.65
Price in Exchange Price in
Argentina rate US$
4.13 pesos 3.50 $1.18
(market)
Price in US$ is less than price in US peso is undervalued
Finding PPP based on Big Mac price
What exchange rate would make the Big Mac cost
the same in both countries?
Price in Exchange Price in
Argentina rate US$
4.13 pesos 3.50 $1.18
(market)
4.13 pesos ? $2.65
(PPP)
Finding PPP based on Big Mac price
What exchange rate would make the Big Mac cost
the same in both countries?
PPP exchange rate = Price in Argentina/Price in
US
Price in Exchange Price in
Argentina rate US$
4.13 pesos 3.50 $1.18
(market)
4.13 pesos 1.55 $2.65
(PPP)