The News-Magazine the Economist Regularly Publishes Data on the So

Essay

The news-magazine The Economist regularly publishes data on the so called Big Mac index and exchange rates between countries. The data for 30 countries from the April 29, 2000 issue is listed below:

The concept of purchasing power parity or PPP ("the idea that similar foreign and domestic goods … should have the same price in terms of the same currency," Abel, A. and B. Bernanke, Macroeconomics, 4^th edition, Boston: Addison Wesley, 476)suggests that the ratio of the Big Mac priced in the local currency to the U.S. dollar price should equal the exchange rate between the two countries.
(a)Enter the data into your regression analysis program (EViews, Stata, Excel, SAS, etc.). Calculate the predicted exchange rate per U.S. dollar by dividing the price of a Big Mac in local currency by the U.S. price of a Big Mac ($2.51).
(b)Run a regression of the actual exchange rate on the predicted exchange rate. If purchasing power parity held, what would you expect the slope and the intercept of the regression to be? Is the value of the slope and the intercept "far" from the values you would expect to hold under PPP?
(c)Plot the actual exchange rate against the predicted exchange rate. Include the 45 degree line in your graph. Which observations might cause the slope and the intercept to differ from zero and one?