Suppose that the price of a Big Mac is a good approximation of the price level in the country. A Big Mac costs £2 in London and $3 in New York

a) If purchasing power parity holds, what is the exchange rate between the U.S. dollar and the British pound?
b) If the current exchange rate is $1.6 per pound, what is the dollar price of a Big Mac in London? What do you predict will happen to the exchange rate? Explain.
c) The exchange rate between the U.S. dollar and the Russian ruble is 30 rubles per dollar. If purchasing power parity holds, what is the price of a Big Mac in Moscow?

a) If purchasing power parity holds, the dollar price of a Big Mac in London must be the same as that in New York. This is the case when the exchange rate is $1.5 per pound. With this exchange rate, the dollar price of a Big Mac in London is £2 × 1.5 dollars per pound = $3.
b) If the current exchange rate is $1.6 per pound, the dollar price of a Big Mac in London is
£2 × 1.6 dollars per pound, which is $3.20. If the price of a Big Mac represents the price level in the country, British goods are relatively more expensive than American goods. The quantity of the U.K. imports demanded decreases in the United States and the quantity of U.S. exports demanded increases in the United Kingdom. The demand for dollars in the foreign exchange market increases and the demand for pounds decreases. As a result, the dollar appreciates against the pound until the purchasing-power-parity exchange rate is restored.
c) If purchasing power parity holds, the dollar price of a Big Mac in Moscow must be the same as in New York, that is, $3. Given the ruble/dollar exchange rate, the price of a Big Mac in Moscow is $3 × 30 rubles per dollar, which is 90 rubles.