Nov 06 2007
Burgernomics and Purchasing Power Parity
Published by Jason Welker at 11:06 am under Balance of Trade,China,Exchange Rates,Macroeconomics,Protection
The Big Mac index | Economist.com
In IB Economics we’re studying the theory of exchange rates. A floating exchange rate system should be in equilibrium when the rate enables people in different countries to buy the same basekt of goods with an equal amount of money. In other words, If I walk into McDonalds in the US and have to pay $3.00 for a Big Mac, then board a plane, land in Shanghai and walk into a McDonalds there, the price I pay in Shanghai should, given current exchange rates, be the same as what I paid in the US. In reality, a Big Mac in Shanghai costs about 56% less than one in the US. This tells economists something about the value of the Chinese RMB.
If the price of a particular basket of goods for Americans is higher than the same basket of goods for Chinese given current exchange rates, than that would be a sign that the Chinese currency is undervalued. In the long-run, “exchange rates should move towards levels that would equalize the prices of an identical basket of goods and services bought in either of the two countries whose exchange rates are being compared.” This concept is known as Purchasing Power Parity (PPP).
China has been dealt harsh criticism and even been threatened with extreme protectionist measures (such as a proposed 27% tariff on all Chinese imports!) lately by the US in response to its interference in the foreign exchange markets to control the value of the Chinese Yuan. Many say that the yuan is grossly undervalued, giving China an unfair advantage over domestic producers in the US and elsewhere. As a closely managed yuan is kept artificially weak, Chinese products appear far cheaper than those from other countries, harming domestic industries in the US and elsewhere.
One way to test the level of undervaluation of the yuan is to apply the principle of PPP. If we could compare the price of a particular basket of goods (or even ONE good that can be bought in both countries), then we can determine whether at current exchange rates the RMB is under or over-valued. Luckily, the Economist magazine has developed its own measure of PPP, and it’s chosen one product that can be purchased in nearly every country in the world, the BIG MAC!
The table below shows by how much, in Big Mac PPP terms, selected currencies were over- or undervalued at the end of January… The most undervalued currency is the Chinese yuan, at 56% below its PPP rate; several other Asian currencies also appear to be 40-50% undervalued.
The index is supposed to give a guide to the direction in which currencies should, in theory, head in the long run It is only a rough guide, because its price reflects non-tradable elements—such as rent and labour. For that reason, it is probably least rough when comparing countries at roughly the same stage of development. Perhaps the most telling numbers in this table are therefore those for the Japanese yen, which is 28% undervalued against the dollar, and the euro, which is 19% overvalued. Hence European finance ministers’ beef with the low level of the yen.
Discussion Questions:
- What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
- How has China intervened in currency markets to maintain the value of the RMB at such a low level?
- What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
- If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
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About the author: Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course.
Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this authorRelated posts:
- Purchasing Power Parity – “for the inebriated masses”
- Exchange rates, currency manipulations, and the balance of trade
- Beijing caves in to the indisputable power of the MARKET!
- Sample IB Economics Internal Assessment Commentary – Understanding the ECB’s bond-purchasing program
- China’s “silver bullet” – a strong RMB could solve her biggest economic woes…
The index does not take into account of the vast difference in production costs in countries such as China and America. It also does not take into consideration the taxes a country may place on particular goods in the market such as the VAT, or business tax.
Since China exports much more than it imports, it has a huge current account surplus. Thus, it has a lot of surplus in its official reserves account, which enables it to keep the RMB low.
The Europeans may argue that the Japanese Yen is not the value it is supposed to be. It is much lower, which gives them an unfair advantage in their exports because Japanese goods seem relatively cheaper. This is similar to the American argument against the undervalued RMB.
It would probably appreciate the RMB because foreigners demand a high amount of Chinese exports which increases demand for RMB, appreciating Chinese RMB. This would certainly make Chinese goods less price competitive as their goods will seem more expensive.
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What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The index does not take into account the taxes and the production costs of the goods, for example it would be much cheaper to hire workers to make big macs, therefore the cost of production is cheaper. Which means big macs can be sold at a lower price while Maciedees still makes the same amount of profit.
How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has a lot of surplus in its official reserves account because it exports so much more than it imports. This suplus allow the chinese government the keep the RMB at a lower price.
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What are two likely complaints the Europeans have against the value of the Japanese Yen?
Similar to the American arguement against the RMB, the europeans argue that the japanese Yen is undervalued, thus making japanese products relatively cheaper.
If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
The value of the RMB would most likely increase, in which case the US would import less chinese goods than it does today. The chinese goods will be relatively more expensive.
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The shortcomings are that this index is based on a single good that is controlled by a corporation that desires to maximize profit and will therefore change the prices according to the maximum amount of profit that they will make from the local people. An American or European price for a Big Mac is probably too expensive for most Chinese people. Also there are governments that will place certain taxes upon goods that they view as harmful.
China has intervened by using its interest rates to control the exchange rate and keep the dollar relatively weak to most developed country's currencies.
The argument of the Europeans is likely to have the same background to the American-Chinese complaint, that the undervaluation is causing Japanese goods to appear to be cheaper than they actually are. However, Japan is a more developed country and doesn't export mass produced goods but high quality technology and competes with European producers in a completely different market than that of Chinese producers.
The RMB will appreciate because the demand for RMB in the world is high because of the high demand for Chinese goods all around the world. This would create problems for the Chinese economy because as it's currency appreciates, it becomes less cheap to produce there and will likely slow down the amount of investment from foreign companies there, and the amount of exports will decrease as well.
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What the Big Mac index does not take into account is the input factors (such as production costs and local taxes) that have been put in place in the foreign countries. Different costs to production will mean that different McDonalds businesses around the world will be able to provide the Big Mac at different prices. For example, the price of meat, salad, and tomatoe will be different in different countries, because maybe, all of those are readily available in that country, reducing over all production costs.
China has been running a fixed exchange rate, to keep their currency at a very low level to make their products seem cheaper to foreign nations. They do this by buying foreign currencies with their RMB, or using their reserves of foreign currencies to buy their own currency.
Europeans will argue that the undervaluation of their goods will attact their consumers to buying Japanese goods instead of domestic goods, leading to more imports than exports, meaning that there will be a current account deficit, and a depreciation of the Euro.
The RMB will shoot through the roof. The value will go so high that there will be massive appreciation of the RMB. Pretty soon, the RMB will be too expensive for US consumers, meaning that the US consumers will look to other countries to buy products.
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The Big Mac Index is not capable of fully depicting the over- and under- valuation of various currencies in terms of Big Macs for several reasons.
Firstly, in some countries, eating at an international fast food restaurant such as McDonalds is cheaper than eating at local restaurants, and also the concept might not be as demanded in countries such as India as in America.
Importantly, the social 'class' which is found to eat regularly at such fast food restaurants world wide is not exactly representative of the nation-wide economy as a whole. This could also possibly include local taxes where the restaurant is situated which are higher or lower than the surrounding areas.
Lastly, the constituents of producing a Big Mac include the individual ingredients and labor. If certain Big Mac ingredients such as ketchup are taxed heavily in the region, the price of the Big Mac will increase however, this does once again not represent nation-wide rates and duties.
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So far, it has been mentioned that different taxes (indirect taxes) and production costs have an effect on the price of Big Macs in difference countries, and that the BMI fails to account for this. What about consumer tastes? If Americans love Big Macs, this potentially means the demand for Big Macs in the US is higher than in a country where Big Macs are less popular. Of course, different countries will have different supply curves for burgers, but if demand is consistently high (i.e. outstrips demand), this could cause an increase in the price of burgers in a certain country.
On another note, I found it interesting that there is also an IKEA-index, an iPod-index, and a Starbucks-index ("lattenomics") serving the same purpose as the BMI.
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The shortcomings of the “Big Mac Index” in depicting the true under or over-valuation of various currencies is that there are certain local costs that are worked into the price of a Big Mac and as such these will change the costs. For example labor costs in India or vastly lower than in the United States (minimum wage) and so to make the same profit an Indian firm can charge much lower for its Big Mac. Additionally taxes vary from region to region and a VAT tax would be on the price of the item. Additionally the cost for land is not taken into account (it may be more expensive in a smaller more dense nation such as Denmark than in the open spaces of the USA.)
China intervened in currency markets to maintain the value of the RMB at such a low level by merely keeping it pegged to the USD. If one dollar is always equal to 10 RMB for example, then now matter how much the RMB is worth the exchange rate is still .1 (or 10.) This gives an unfair advantage to the PRC of course.
Two likely complaints Europeans have against the value of the Japanese Yen is that it is too low and as such is unfair competition, stifling domestic production and therefore the domestic economy. These are in effect the exact same complaints the US has against the PRC.
If the Chinese were to halt all interference in the currency markets, the value of the RMB would increase drastically and so would its purchasing power. The balance of trade to China between the US, while still focusing heavily on Chinese exports and American imports, would be less strong, with more American exports and less imports of Chinese goods.
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1. The index does not take into account the taxes and the production costs of the goods, for example it would be much cheaper to hire workers to make big macs, therefore the cost of production is cheaper. Which means big macs can be sold at a lower price while Maciedees still makes the same amount of profit.
2. China has intervened by using its interest rates to control the exchange rate and keep the dollar relatively weak to most developed country’s currencies.
3. Europeans will argue that the undervaluation of their goods will attact their consumers to buying Japanese goods instead of domestic goods, leading to more imports than exports, meaning that there will be a current account deficit, and a depreciation of the Euro.
4. The value of the RMB would most likely increase, in which case the US would import less chinese goods than it does today. The chinese goods will be relatively more expensive.
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Elijah,
Good point about China keeping its currency low by pegging it to the USD. This does make sense as the exchange rate between the RBM and the Dollar never changes, but this means that the RBM will stay at a depreciated rate.
Sara
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1.It doesn't count for differences in things such as labor or rent that could also affect the prices of Big Macs.
2. China intervenes in the currency market by pegging the RMB to the US dollar.
3.The EU complains that the yen is too low, as the Big Mac index shows that the yen is undervalued. This causes unfair competition. It is similar to the US complaints against China.
4.The RMB would likely rise in value. Chinese exports would become relatively more expensive. US consumers would buy fewer of them, reducing the trade deficit.
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Sara,
You mentioned that the Big Mac index does not account for differing costs of production. Could the costs of production be considered a part of purchasing parity? If the same amount of money buys more labor in one country than in another, then the two countries will not have purchasing power parity. Because of this, the Big Mac index could still be seen as accounting for differences in things such as labor costs.
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1. The big problem is the fact that the Big Mac is only one item. It may be the one thing that is valued most in certain areas and seen as junk in others. It could be a cultural thing. This is nowhere near close to being a market basket.
2. One particular move they have made has been to buy up the debt of foreign nations such as the United States. By buying these currencies and other holdings, they decrease the money supply of that currency and it appreciates in relation to the Chinese yuan.
3. The yen is relatively inexpensive compared to the Euro. Also, they’re probably complaining that the Japanese are acquiring vast amounts of Euro currency, raising their value and lowering that of the Japanese. This is similar to the complaints of the U.S. against the Chinese.
4. I think due to the PPP theory, it would eventually balance out with the dollar and euro over a long period of time. The exchange rate wouldn’t equal one, however, the worth of one good in China would be almost identical to the worth of that same good in the U.S. and Europe. Eventually, the balance of trade would even out.
Trevor Tezel
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1. What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The Big Mac index doens't count in labour costs or taxes set by the chinese government. Taxes and labour costs will vary from country to country hense this is a problem.
2. How has China intervened in currency markets to maintain the value of the RMB at such a low level?
Using government intervention, the Yuan has remained at such a low level. It has been set and the government continues to do so to this day, eventhough it had received alot of criticism.
3. What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
The Europeans will possibly complain more about the human rights issue as well as possible low export costs, which is affecting their economy and leading to less exports, hense there being less demand but more supply which means depreciation of the Euro.
4. If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
It would cause a fair amount of chaos initially but the Yuan would rise and become a lot less undervalued. Exports would be alot less attractive and consumers might be more tempted to choose for other goods from US producers as they are now cheaper or equivalent.
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Mattea,
I find it interesting that you identify labor and rent as the two main factors which make the Big Mac index different for each country. It makes sense, though. The Euro is seen as an appreciated currency. We know that in Europe the cost of labor is relatively high because many government policies are geared towards the working man and they insured success and prosperity. Rent would also be high in such small countries where there is not vast land space to develop. Thanks for inadvertently clarifying this point for me!
Trevor Tezel
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1. One of the main shortcomings of the Big Mac index is that it does not account for non-material tradeable goods like rent. Also, I have eaten from McDonalds in the US, the UK, and France, and everywhere it tastes different. The ingredients used in other countries are different, and therefore have slightly different prices. (A good example of this is that Coca-Cola is made with corn syrup in the US but sugar cane in Mexico and most of Europe, which is why Coke is so much better outside of America!)
2. China has used interest rates to control the level of its currency. Also, as Trevor stated, it has bought up American debt, in US dollars, which has maintained its currency levels.
3. Europeans are upset that the Yen is undervalued as compared to the Euro. This is very similar to the complaint that the United States has with the Chinese.
4. The RMB would rise in value if China halted all interference in the currency market. This would mean that the United States would import less from China, increasing domestic American production. It would mean that Chinese production would fall dramatically, a major shift in the global balance of trade.
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Ralph,
I thought that it was very interesting that you cited human rights as an issue with devalued currency. It's true, a nation does suffer when its currency is devalued. It means that its goods are very cheap, which is good for consumers. However, this means that workers are paid far less than they are in countries with currencies with higher values. It's important that we consider the human aspects of exchange rates.
Thanks for making this important point,
Chamonix
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What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies?
The shortcomings of the Big Mac Index is the exclusion of localization and negligence of the cost of productions. Under the principle of capitalism, firms have the power to change prices in order to meet with their cost of production and maximize profit. Cost of production alter at various locations, hence, Big Mac will have different prices around the world.
How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has deliberately devaluated its Yuan to a low level in order to make its export industry attractive to foreigners. China has intervened into the currency market by selling its own reserve for RMB and purchasing foreign currency.
What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Europeans have similar complaints the US has against China because yen is undervalued against euro. Japanese import is attractive to Europeans, creating an unfair international competition.
If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
The value of RMB is likely to appreciate because of China's strong economic power and possibility of its future. Investors are more likely to invest into countries that have promised future success and stability than countries with weak, stagnating economy.
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@Ralph
Good point about human rights issue. I didn't even think about it. The Chinese system is very ironic because the country is prospering tremendously from its export industry, yet its people are concerned with the living standard and quality of life. Economically speaking, it would not be surprising if China became a developed country, if not the humanitarian values were considered.
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What the Big Mac index does not take into account is the input factors (such as production costs and local taxes) that have been put in place in the foreign countries. Different costs to production will mean that different McDonalds businesses around the world will be able to provide the Big Mac at different prices. For example, the price of meat, salad, and tomatoe will be different in different countries, because maybe, all of those are readily available in that country, reducing over all production costs.
Using government intervention, the Yuan has remained at such a low level. It has been set and the government continues to do so to this day, eventhough it had received alot of criticism.
The EU complains that the yen is too low, as the Big Mac index shows that the yen is undervalued. This causes unfair competition. It is similar to the US complaints against China.
If the Chinese were to halt all interference in the currency markets, the value of the RMB would increase drastically and so would its purchasing power. The balance of trade to China between the US, while still focusing heavily on Chinese exports and American imports, would be less strong, with more American exports and less imports of Chinese goods.
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1) I think the most important shortcoming of the BigMac index is that it doesn’t include the input costs like labour cost, rent, the cost of raw materials like the meat, salad, etc. These costs can be different in every country that produces BigMac. So that different cost of making BigMac could be result in different prices of BigMac in different countries.
2) By the policies of Chinese government they continue to keep their currency undervalued by using fixed exchange rates. They provide this stable situation by having foreign money flow in China like when they export loads of good to the USA there will be loads of dollar going in the China so they use these foreign currencies to buy their own currency.
3) I think it is almost the same situation. From the table it can be seen that Japanese Yen is undervalued against the Euro which make Japanese goods cheaper for consumers in the Europe. Because of that reason like in the USA about Chinese goods, there will be a risk to have unfair competition in countries using Euro. Moreover, as we know Japan is really developed about technology and vast majority of technological goods should be imported from Japan as the goods are manufactured there. So as Japan export more they profit more by the help of their undervalued currency against Euro.
4) As a result of this, Chinese Yuan start to appreciate in value which makes it less undervalued against the US dollar. So Chinese exports start to fall as they lose their advantage on cheap prices of goods. Because of that the US manufacturers can be attracted more as they could compete with Chinese goods at last.
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I agree with you that the BigMac index does not include input factors. Good for you to think of local taxes as well I did not think of them in my comment. Also, you are right in the third question by saying there will be less imports from China and more American exports as a result of change in RMB.
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1. It does not count the costs of labor and rent.
2. China intervened in currency markets to maintain the value of RMB by buying foreign currency with RMB. They also use the interest rates to control the currency of RMB.
3.The complain is similar where Yen is undervalued agaisnt euro.
4.The value of RMB will appreciates which means products of China will become expensive too. Exports will decrease because China products are less in demand. There may be lesser foreign country who invest in China and inflation may happen if the money value is too high.
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True, some investors do not want to take risks.
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1. The Big Mac Index does not take into account different factors of cost when comparing currencies. For example, although a big mac is less in Chinese Yuan, the production cost for the big mac is lower whereas the production cost in the US is more.
2. China's level of exports is currently much higher than it's levels of import therefore the RMB is low although there is a surplus of their account.
3. The Japanese Yen is currently very cheap therefore the Europeans might argue that the Japanese are using this as an unfair advantage to keep their export costs low. The US has similar complaints against China because the Yuan is also very cheap meaning that labor costs in China are much less than the US.
4.The value of the RMB would increase if the Chinese were to halt all interference in the current markets because the demand for Chinese exports would increase. The price goods would not increase however it would seem much higher.
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There is not ketchup on a Big Mac. It's called special sauce and it's delicious.
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1)The Big Mac Index does have some shortcomings, first of all many countries implement a value-added tax, which differs in every country. Also inflation is in every country different and this affects the price of the Big Mac.
2)China exports a lot more than that it imports, which gives such as low RMB level.
3)That the value of the Japanese Yen is undervalued against the euro, the same counts for the Yuan, which is also undervalued. Therefore the complaints are similar as the EU feels they do not have a fair change on the market, as they cannot compete against the low Chinese and the Japanese that sell their products for a very low price.
4)If the Chinese were to halt the interference in the currency markets then the value of the RMB will definitely increase. This also means that Chinese products become more expensive, probably hurting their exports. Therefore the trade balance between the US and China will change. Now China exports a lot of products into America, which means America imports a lot of products. However when China’s products become more expensive, this might turn around.
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I agree with you on the point that the price of goods actually does not increase, but that it only seems higher. But why would the demand for Chinese exports increase then? Isn't it that if the price of the goods seem higher, that the Chinese will export less?
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1. The first shortcoming of the Big Mac Index provided by The Economist is clearly the fact that the “true” under/over-valuations of various currencies cannot be determined by comparing the prices of a Big-Mac. Yes, the Big-Mac is sold everywhere in the world, why? Simply, because McDonalds is a large multinational corporation. I would strongly think that the valuations of different currencies would be better analyzed if it compared daily necessities. Another flaw in the Big Mac Index is that, external factors are not taken into account. For example, the cost of production of the Big Mac in different countries. Is it not reasonable that the McDonalds outlets in different countries sell their Big-Mac relative to the cost of production? As well as the currencies shown in the Big-Mac index does not incorporate the interest rate/percentage of money taken during currency transactions.
2. I am not entirely sure if China has “intervened” in the currency markets to keep the value of RMB at a low level, but China has been manipulating currencies; not specifically the RMB but the US dollar. China would buy the US dollar from the currency market (with the large amount of trade surplus from all the Chinese exports they sell) to keep the US dollar at a high value compared to the Chinese RMB. This way, the value of the Chinese RMB would be lower than the US dollar.
3. I can only think of one complaint that the Europeans would have against the value of the Japanese Yen. It is sated in the post above that the Japanese Yen is undervalued compared to the Euro by 19%. The undervaluation of the Japanese Yen towards the Euro would mean that European goods are sold at a very expensive price, and therefore the European export sectors would not benefit from this situation. However, the European consumers would benefit from this, as the price of Japanese goods will be low/lower. In the sense, both situations are similar as one party’s currency is under-valued compared to the other, which is causing trouble for the ‘over-valued country’, but it is not specifically stated as to why the Europeans are ‘beefing’ with the low level of Yen. Another complaint that the Europeans may have is the issue with unemployment due to the under-valued Yen compared to the Euro. Although having said all this, I am clueless as to why the Europeans would beef towards the “under-valued” Japanese Yen, when (out of personal experience) Japanese products are exceptionally expensive.
4. One thing for sure is that the value of the RMB would rise to the point where Americans and the rest of the world are happy and not complaining about the “under-valued” Chinese currency. Then again, the appreciation of the RMB would lead to other problems. First of all, there will be less Chinese exports as the higher price of Chinese goods will lead to a lower demand for them (in the US), which would ultimately damage the Chinese export sectors. I would also imagine that the Americans would start complaining about the high prices of Chinese export (inflation) as well. The balance of trade between the US and China would all depend on the degree of appreciation of the RMB. Assuming that the RMB would appreciate significantly, China would have a trade deficit due to the ‘unattractive’ Chinese exports (due to the higher price). However, when looking at this situation from a larger perspective, the Chinese exports may have better quality and industries may have a better working environment for the workers due to the appreciated RMB value.
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To: Jackson Mote
1. It really makes sense though, the whole production cost being lower in China than other countries. First of all, they have cheap labor, and secondly they are most likely able to obtain the ingredients/goods a lot cheaper in China.
4. The demand for Chinese exports would decrease, and the price of goods will increase. If you look at it from the Demand and Supply perspective, the higher price (due to the appreciated RMB) would mean that there is low demand for products. Then again, it all depends on the elasticity of the product too. For burgers.. Really, who cares if the price of burgers go up? Right? Simply for 1. There are other substitutes and 2. Cultural differences (For instance in China, burgers would not be as popular).
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1.What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
Cost of labour and rent are not accounted which is the main shortcomings of the Big Mac Index. Due to these the costs of and the tastes of Big Mac is changing according to the place or country you are eating in.
2.How has China intervened in currency markets to maintain the value of the RMB at such a low level?
Government uses interest rates and keeps its currency, Yuan, at low. Also as it stated in the article China buy the US debt in US dollars.
3.What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
The Europe’s and the US’s situation is almost the same. Because Japanese Yen is lower in terms of value than Euro so that this make the goods cheaper for the consumers. This situation is the same for US because Chinese Yuan has a lower value than US dollar.
4.If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
This situation will cause Chinese goods not that cheaper as the past which will lead less demand on Chinese goods and the less US imports Chinese goods the more the domestic production in US will benefit.
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To Chamonix.echl.f09,
I really like the first answer actually. Thanks for explaining the answer with the real world examples and your experiences.
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1.What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
In my opinion first shortcoming of the Big Mac index is the lack of standardization of cost in different countries even if McDonalds is a worldwide corporation. The reason for that situation is the various currencies. Because cost of production such as labour, rent, or raw materials can differ country to country. For example in China these factors of production is cheaper than most of the country so that cost of Big Mac will be cheaper.
2.How has China intervened in currency markets to maintain the value of the RMB at such a low level?
When we look at the China’s trade balance we may see that China’s exports is more than imports because the products are so cheap that makes them more desirable. That is why they have a less RMB level.
3.What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Yes, they have the similar complaints about the issue; Yen is undervalued against Euro.
4.If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
In my opinion China’s products will be more expensive so that the gap between countries will decrease. That means value of RMB will be appreciated.
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Hi Enno,
I agree with you.
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1-While the price of Big Mac is depicted, there are some things which are taken into account. For instance, the cost of production or taxes in the foreign countries. As the locations of the markets differ, the cost of ingredients also differs. These are the shortcomings of Big Mac index.
2-The path China follows is to keep their currency undervalued and to keep the foreign currencies – especially US dollars- overvalued. What it simply does is to buy US dollars and keeps it overvalued and its own currency at low levels. Then since the price of Chinese goods would be cheaper than US goods, the consumers would prefer Chinese goods. This would be hard for the US domestic producers whose currency is high and have fewer amounts of sales.
3-In the text, it is stated that the Japanese yen was 28 % undervalued while euro is 19 % overvalued when the price of Big Mac is taken as the basis. As one of them is undervalued, the price of Japanese goods is regarded as low in a comparison with the European goods. That is why, European domestic producers may complain about low amounts of sales since European consumers would prefer Japanese products. Therefore, it can be concluded that it is the same complaint like US has against China.
4-If the Chinese were to halt all interference in the currency markets, the value of RMB would rise. With the appreciation of it, the domestic producers, especially in the US, would be glad with the fact that they would not confound with dumping from China. As the domestic sales increase, the value of overvalued currency may fall
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I agree with you on your last answer. As the value of RMB rises, the demand for Chinese goods would fall in the US. The tension among the US and China would settle down a little.
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1.What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The taxes , the cost of production are taken into account. Every country has different capital resources, labour force that makes the cost of production to be various. Also different currencies are also shortcomings of Big Mac Index.
2.How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has a greater rate of exports than imports and it keeps its currency at low level which helps to maintain RMB value.
3.What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Japanese yen is undervalued compare to euro which makes Japanese exports to euro cheaper and preferable for consumers. The same issue is valid for US against China since Chinese exports are cheaper and damage domestic producers in US.
4.If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
RMB value would increase which would be in favour of US domestic producers as the undervalued currency of China would fall and domestic US producers would start getting high demands and making profits.
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1. Some external factors are not taken into consideration such as the cost of production which may differ from country to country. For instance, wages might be varying in countries. Besides, the popularity i.e. the demand for Big Mac migh be so different.
2. China has a fixed rate against the US dollar. China keeps an incessant demand for US treasury securities and other financial and real assets. Besides, it has huge reserves of US dollar in its central bank. So, it is able to supply US dollar in the foreign exchange market. Thus, China is able to have a fixed rate against US dollar.
3. They have similar complaints. European countries and the USA think that there is not a fair competition between domestic producers and Chinese or Japanese producers. However, European countries should be aware of the fact that they are also responsible for this unfair competiton because of their overvalued Euro.
4. The value of yuan would increase because there is a huge demand for Chinese products. The increase in the value would lead to a higher level of price for Chinese products. Therefore, the demand for Chinese products would fall. The domestic producers would become more competitive. All in all, the imports in the US would fall, whereas the imports in China would increase.
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1. It focuses on only one good, and does not take into account the differences in the good’s supply and demand between countries.
2. They have intervened in the markets by buying foreign currencies, which raises the demand and price of the foreign currencies while keeping their currency relatively low.
3. A big mac costs much less in Japan ($2.31) than in a Euro country ($3.82). Eurozone countries could have the same problem with Japan that the US does with China.
4. The value of the RMB would significantly rise. The US would import less goods from China, as they would not seem so cheap.
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@ Mehmet
I agree with your answers. China would probably also see a decrease in their exports because of the increase in the value of the yuan.
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1.When we compare currencies, in The Big Mac Index the different factors of cost does not take in to the account. For example, although a big mac is less in Chinese Yuan, the production cost for the big mac is lower whereas the production cost in the US is more.
2. China's level of exports is currently much higher than it's levels of import therefore the RMB is low although there is a surplus of their account.
3. Yen (the Japanese current) is currently very cheap therefore the Europeans might argue that the Japanese are using this as an unfair advantage to keep their export costs low. The US has similar complaints against China because the Yuan is also very cheap meaning that labor costs in China are much less than the US.
4. RMB’s value would increase if the Chinese were to halt all interference in the current markets because the demand for Chinese exports would increase. The price goods would not increase however it would seem much higher.
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Another key factor may be that along with goods, the US imports raw materials from China, and as those become more expensive the price for final US goods would increase, that might turn around to US as a problem with trade because of that high inflation.
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1. Well, the Big Mac Index does take into account the different costs of production in different countries. The reason a Big Mac might be so lowly priced in China, might be because it costs a lot let the produce it: the beef is cheaper, etc… Furthermore, wages in China are a lot lower and the popularity of the Big Mac might be a lot different.
2. China keeps it currency low by maintaining its exports higher than its imports. By doing so, the currency remains low (undervalued), keeping Chinese goods cheap (ie. Big Mac).
3. The European complaints against the Japanese are likely to very similar to the US’s complaints against the Chinese. Both are complaining about Chinese and Japanese exports being so cheap, that their own domestic firms cannot even compete. However, the Europeans must realise that their currency is overvalued, making their goods too expensive.
4. If the Chinese were to halt interference in the currency markets, the value of the RMB would appreciate. This would decrease Chinese exports and increase US exports.
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# Mehmet M Suma
Hi Mehmet, I agree with your answers. A great response to this worksheet! I agree with the fact that cheaper CHinese goods can be attributed to lower wages, lower popularity and low costs of production. Beef might be cheaper in China!
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1.What are the shortcoming of the Big Mac Index in depicting the true under or overvaluations of various currencies?
First of all, the Big Mac Index only takes into account a single product. While this product is been sold in a majority of the countries around the world it only takes into account one of millions of products sold and one company deciding to sell its burger at different prices.
2.How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has done a couple of things to maintain a low value of its RMB. First of all it has increased the supply of the RMB by printing a lot of that currency. This increases the supply and thus decreases the value of one RMB. Secondly, China has bought many foreign currency reserves in order to drive down the price of the RMB. Buying other currencies increases the demand for those currencies, which means the RMB becomes relatively less valuable, and in buying other currencies it has sold its own, which increases the supply of the RMB on the currency market, which similarly to printing more money, increases the supply and decreases its value.
3.What are the two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Because of the undervaluation of the Japanese yen, Europeans would argue that this difference in currency values is unfair since the two countries are at an equal level of economic development. Also, because of the undervaluation of the yen, the Euro would argue that it makes it harder for them to export goods to Japanese, while easier for Japan to import goods into Europe.
4.If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
If China suddenly seized to interfere in the currency market, the value of the RMB would rise. This is because, due to their high number of exports, the RMB is in demand. By being in demand, the RMB becomes a more valuable currency to have and in return its value would rise.
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To add on to my last answer, the number of goods that China exports would fall since their prices would be higher relative to other countries' goods. The number of Chinese imports would increase because the US would be able to compete since their currency would be of lesser or more even value with the Chinese RMB. This would increase the balance of trade for the US and decrease the balance of trade for China.
Noah
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@ Jackson Mote
3. Also, one important factor about the relationship between Europe and Japan is that the Europe's countries and Japan are at similar points of economic development. China can argue that its economic development versus the US is much lower thus it has a reason to have a lower valued currency but Japan cannot make this argument with many countries that use the euro.
Noah
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1. First of all, the Big Mac Index only takes into account a single product. While this product is been sold in a majority of the countries around the world it only takes into account one of millions of products sold and one company deciding to sell its burger at different prices.
2. One particular move they have made has been to buy up the debt of foreign nations such as the United States. By buying these currencies and other holdings, they decrease the money supply of that currency and it appreciates in relation to the Chinese yuan.
3. The yen is relatively inexpensive compared to the Euro. Also, they’re probably complaining that the Japanese are acquiring vast amounts of Euro currency, raising their value and lowering that of the Japanese. This is similar to the complaints of the U.S. against the Chinese.
4. As a result of this, Chinese Yuan start to appreciate in value which makes it less undervalued against the US dollar. So Chinese exports start to fall as they lose their advantage on cheap prices of goods. Because of that the US manufacturers can be attracted more as they could compete with Chinese goods at last.
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What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The index might not take into a account the costs of producing the big for each country. Example: Argentina has a lot of meat production which makes it easier to make the Big Mac.
How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has a lot of surplus in its reserves accounts caused be its high exports and low imports. This surplus allows the chinese government the keep the RMB at a lower price, therefore making it more appealing.
What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
The Europeans complain that the Yen makes it harder to compete against and that its undervaluation attracts more customers due to the low prices.
Yes; US also complains for the undervaluation of RMB which makes it harder to compete and increases imports.
If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
The value of the RMB will change and will be more expensive which would reduce US imports of Chinese goods because they are more expensive.
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@ Kaj
Hi;
I totally agree with your answers I believe you did a great job giving correct answers.
It helped me to understand better the topic.
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-What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies?
Here we can say that the main shortcoming is cost of labour and rent. If you eat Big Mac in different restaurants you the taste of it will be different.
-How has China intervened in currency markets to maintain the value of the RMB at such a low level?
The most important way of maintaining the value of RMB at such a low level is interest rates. China uses interest rates to keep Yuan.
-What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
We can say that their complaints are similar. Because the value of Japanese Yen is lower than Euro. This is good for consumers because the products become cheaper. This situation is similar to US and China because Chinese Yuan is less valuable than US Dollar.
-If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
After this situation the products in China become more expensive so as a result of this situation people will demand less and demand will decrease. As a result US will import less goods from China.
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Thanks for your answer. But for the 3rd question if you had mentioned about the China and US it would be better
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1.The Big Mac Index fails to take into account comparative advantage which may have an effect on the ability of a country to produce goods for a cheaper price. Their methods for production may be more cost effective allowing them to offer lower prices.
2.The Chinese have purchased large amounts of foreign currency in the form of bonds in order to stifle supply and thus appreciate these currencies as their values gain. This therefore makes Chinese goods more appealing as it increases the supply of the Chinese currency thus maintaining its low level.
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3.The Europeans argue that there is no justification for the undervalued Japanese Yen as they are at the same level of economic development as the Europeans. They should have achieved purchasing power parity, according to the Europeans, by now. This is somewhat different to the arguments made by the US as China is still considered a developing country. However the US argues that the Chinese are interfering in the market to ensure that their currency doesn't appreciate. This provides incentive for American consumers to purchase Chinese goods.
4.The value of the RMB would probably appreciate due to the drop in demand coming from the US as its currency depreciates due to less bonds being purchased by China. As this occurs, more and more investors would seek Chinese bonds as their value continues to appreciate. More and more goods would be purchased in the US by the Chinese as the value of the US dollar drops and the value of the RMB appreciates. Trade would essentially become more balanced between the two nations.
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@Jackson Mote
I agree that the value of the Chinese RMB would appreciate however I don't agree that the demand for Chinese goods and services would increase a result. The rising RMB would mean that foreign countries would have less purchasing power in China thus less incentive to purchase Chinese goods. In fact, Chinese consumers would begin to purhase American and European goods as their values begin to depreciate due to less bonds being purchased by China.
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1.) What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
Cost of production is not taken into account, as it can show a change country to country. However, the other factors like taxes and wages will be taken into consideration when the shortcomings of Big Mac index is depicting true under.
2.) How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China’s exports are considerably more than the imports of it, so that the currency of China is kept in lower level, which also provides RMB at a level. Plus, China in its own central bank has a great amount of US dollar for the exchange of its Money. Thus, maintaining US dollar in the foreign exchange market becomes easier for China.
3.) What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
In fact, it is thought by both of the countries that there is a fair competition between domestic producer, domestic markets and the exporters, the Chinese producers. On the other hand, since the Euro’s value has increased much, this unfair competition is induced by also the European countries.
4.) If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
In this case, the value of RMB may increase and that may also be the USA’s benefit. Plus, when the RMB value increases, the US producers will earn more and so will make more profit than they were having.
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1. What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies?
The problem with the Big Mac index is that it is a good. I know that sounds odd seeing as we are trying to use a good to tell if the currencies are over or under valued, but the statement still stands. Different countries have different regulations about certain goods, or if not goods than ingredients in goods. For instance, the UK has a policy in place that regulates the amount of trans-fat in foods. They have done this by increasing the price of fast food thus artificially increasing the price of the Big Mac. Another example is social regulation of goods. For instance, India is not present in the table because of the Hindu religion protecting cows. If India was on the board the price would probably be very high therefore artificially “overvaluing” the Indian Ruppee. Another problem is that the Big Max Index implies equal transportation and production costs for all countries. This, as we know, is not true. The price of a Big Mac is also very dependent to the amount of competition and the amount of demand in a certain country. If there are many Mc Donald’s, as in the United States, there will be more competition and therefore a lower price for Mc Donald’s goods and therefore the Big Mac. The Big Mac Index also doesn’t account for the national income which would affect the price. That is why in the table, you will notice that poorer countries have a lower price for a Big Mac. Does this mean that the currency is undervalued? Not every country is going to enjoy the Big Mac and therefore the price will change all over the world. This doesn’t necessarily mean that countries that have a higher Big Mac price will have a more overvalued currency.
2. How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China doesn’t necessarily have a REAL devalued currency; it has a relatively devalued currency. What this means is that the Chinese RMB is devalued in comparison to other currencies. This has the same effect as if the currency was simply undervalued. China has kept the RMB relatively undervalued by increasing the value of foreign currency. It can do this buy buying up foreign currency supplies on the international market. This creates a shortage of foreign currency thus increasing the demand. This overvalues the other currencies thus “undervalues” the Chinese RMB.
3. What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
The Europeans are not too fond of the Japanese Yen because of the goods that Japan produces. The EU and Japan are both very well known for their car production and since the Japanese Yen is devalued against the European Euro, the Japanese cars (and goods in general) look more attractive to the European consumer. European car manufacturers are not able to be as competitive because the prices of the European cars will be relatively more expensive because they cost more to produce. If the value of the Yen increases the price of the Japanese exports would rise and thus make the European manufactures more competitive. These complaints are not the same as the ones against China from the United States because the United States is complaining to China because of an array of goods that US producers are not able to compete with. The complaints against the Yen from Europe are mainly focuses on 2 goods, cars and cellphones (cellphones were not discussed because the same principles apply).
4. If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
China is able to keep the value of the RMB artificially low by interfering in the international currency market. If China stops doing this, the value of their currency will increase. This means that their export power will decrease and their import power will increase. This will cause the price of Chinese exports to rise overseas and cause the Chinese people to import more goods. This will greatly affect the United States. If the United States (by some miracle) is able to keep the value of the dollar exactly where it is, the American consumer will purchase less goods from China and more from the domestic market. Also China will be able to import more and therefore will import more from the United States, causing United States’ domestic market to thrive.
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@AydaAyd
I do not understand your response to #1. Are you saying that the Big Mac Index is a suitable metric for analysing a country’s tax policy?
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1.What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies?
The shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies are that comparative advantage and cost of productions are not taken into account. A country may have an “under-valuation” but this may be due to the fact that its cost of production may be lower than the US’s. The employees of a country may be content to work for less money than in another, so it may have a lower value as it will have a lower cost of production. Also, according to comparative advantage, some countries may have certain raw materials that would allow them to produce a product at a lower cost, so it would sell at a lower cost in another country.
2.How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has intervened in currency market in order to maintain the value of the RMB at a low level by exporting more than importing. This allows the government to intervene and keep the RMB at a low price as there will be a surplus. This will undervalue the currency.
3.What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
One likely complaint that the Europeans may have against the value of the Japanese Yen is that the Japanese have a similar purchasing value as many European countries but they still are -28 undervalued. This isn’t fair as it will make Japanese exports and the Yen more attractive to appreciate and thus it will hurt domestic European firms. Another is that they produce a large amount of goods that allow them to export extensively and increase competition in foreign markets. These are similar to the complaints the US have against China because the Yen is also large undervalued (-56) compared to the dollar, thus the US is extensively competing with China’s exports.
4.If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
I think this would increase the value of the RMB and it would be appreciated. The US would import less from China as the price of Chinese goods would most likely increase and likewise China will export less as its currency will be less attractive. The demand for Chinese goods will drop as its price increases. The demand for domestic US goods will increase and domestic firms will better compete with the Chinese imports. In turn, the balance of trade will begin to favor the US unless the Chinese government increases it interest rate.
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@ Quinn Richardson
I like and agree with your answers. Particularly with number 1, I like your response as comparative advantage doesn't seem to be considered in the Big Mac index. This is key as comparative advantage and the cost of production may explain why some currencies are undervalued. Some countries may have more raw resources available or they may have employees more content to work with lower wages. This may allow the country's domestic firms to produce goods at lower costs and therefore sell them at lower costs than others.
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-What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The index is based on one good, that we must remember is not controlled by any government, but rather a large company attempting to maximize profit. Depending on factors of production such as wages paid to workers and the cost of the initial products to produce the goods. Some countries have higher demand for Big Mac's as well as lower minimum wages.
-How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has large reserves of other currencies, thus they have the ability to either buy or sell that currency for other currencies, allowing them to keep their exchange rate at a very low level.
-What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
The complaints the Europeans have against the Japanese Yen are very similar to that of the US against China. They feel the Japanese Yen is undervalued and thus there products are cheaper in Europe taking away from the domestic production.
-If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
The value of the RMB would clearly appreciate, as China is no longer artificially keeping it low. This would make Chinese goods more expensive, thus the US would import more goods. Chinese imports would be less expensive, thus they would import more US goods.
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@Trevor
I like your approach on how the Big Mac may be viewed differently depending on the culture of the country. What must also be considered; however, is the costs of production to produce that goods, as well as any taxes that the government imposes on the item if it feels it is unhealthy.
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What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies?
Even though the product in itself is identical between countries, the price of handing it over the counter differs in terms of taxes, salaries, utilities, housing costs etc.
How has China intervened in currency markets to maintain the value of the RMB at such a low level?
By keeping the yuan artificially weak, China can export their products at a seemingly lower price – at least from the outside perspective. It is done by government intervention and artificial inflation.
What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
The yen is over-valued as the country has been seen as in deflation and having a very strong currency, while production is still quite cheap, making products be likewise. It is not, though, at the same extreme level as the yuan, so Europe cannot be as annoyed and angry as the US is.
If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
It would gain in value as exports are high and imports low, it would even itself out and trade between the US and China would change from being almost strictly one-sided (China to US) to maybe being two-sided.
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@Noah Flaniken
So, about your third answer, while I agree that the relationship between Europe and Japan would be problematic as the undervaluation of the yen causes 'hidden' cheaper exports (if that makes sense), how would you relate it to the relationship between the US and China? Is it at the same level or would you agree that where the US seems very dependent on Chinese products, Europe is not as much relying on Japan.
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1. What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
There are differing costs involved in making a Big Mac in different areas of the world. For example, labor in China and India is much cheaper than in the United States (minimum wage). Also, some of the ingredients can have different costs in different parts of the world, like meat tomatoes etc.
2. How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has intervened into it's currency markets by keeping it at a fixed low value (pegged to the US dollar).
3. What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Europeans get concerned that their consumers will be attracted to the lower prices of Japanese goods. They are pretty much the same complaints the US has of China.
4. If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
The value of the RMB would appreciate like crazy. Because it has been kept artificially low for a very long time, the value will not only go up to market value, but most likely shoot way past it. Soon, the opposite problem will happen for China. The US dollar will be less valuable in comparison, and China will experience all of the problems the US is facing now.
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That's interesting. I have never heard of those other indexes before. Perhaps all international companies could be used as an index? I'm not sure.
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What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies?
Local production costs of a big mac in particular might be different from that of other products, and therefore could affect the price regardless of exchange rates, and as such, not be a good measure of currency value.
What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Europeans might complain that the low value takes away from Europe's domestic sales, since people end up wanting to buy more goods from Japan. Yes, it is similar to US complaints. They complain also about this fact.
If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
Most likely, the RMB would rise. It seems as though China is striving to keep the value down, because it augments exports and decreases imports. This would affect trade between the US and China in that the US would suddenly import fewer goods from China, and export more goods to China.
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Your last response stood out to me as being very clear to me. I like your use of the phrase 'purchasing power'. Your clear analysis of what would happen to the RMB helped me better understand what a lack of China's intervention would cause for american exports/chinese imports.
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What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The Big Mac Index uses the value of a single product to evaluate the worth of an entire currency. Using one product allows for misrepresentations of the data because their are costs involved in the creation of the product: produce, meat, and labor, which vary from country to country. While one country may have inexpensive labor, they may have expensive metals. The two counteract each other; however, they are not both considered in the big mac.
How has China intervened in currency markets to maintain the value of the RMB at such a low level?
China has pegged the RMB to the dollar. The dollar is kept strong because when there is an influx of dollars on the market, China purchases them lowering the supply and raising the demand causing the value of the dollar to increase. Because China can manipulate the dollar, and the RMB is pegged to the dollar, China is able to maintain lower values.
What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Europeans would argue the Yen is kept artificially low. The low value results in unfair advantages in the global market resulting in greater exports for Japan and more imports for Europe changing the Balance of Payments such that Europe is more likely to run a deficit. These complaints are similar to those the US has against China.
If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
I believe the value of the dollar would decrease and the value of the RBM would increase. If China stopped buying dollars, the supply of dollars would dramatically increase, possibly beyond a level which is safe for the economy, and the RBM would increase because of the surplus in trade. However, the decrease in the value of the dollar, and the increase in the value of the RBM would alter the balance of trade so that each country was closer to an even zero balance.
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I found your consideration of minimum wage to be useful as it shows the fixed costs per country. In question two you talked about th ePRC's unfair advantage because it has fixed the currencies; do you believe this gives needed stability to the dollar as the US runs a great trade deficit?
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1. What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
• There are many factors that affect the Big Mac Index in depicting the true under or over valuations of various currencies. One such factor is the different price levels for the ingredients needed to produce the product. The price of the beef patty will differ in China and in American as in China it may be imported whereas in American it might be from a domestic firm. Some other factors include capital goods such as labour needed in the restaurant as in different countries different wages are paid. Machinery is another factor as some countries have different machines for producing the Big Macs and in each country the cost of these machines differ. Tax is another factor that affects the shortcomings of Big Mac and exchange rate.
2. How has China intervened in currency markets to maintain the value of the RMB at such a low level?
• China has lowered the values of the RMB to make exports for foreign countries more attractive so that more countries trade with China increasing its profits as China exports more than it imports. This maintains the value of the RMB at such a low level.
3. What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
• Since the value for yen in undervalued by 28% against the dollar and overvalued by 19% against the euro it is not exactly the same complaint but can be accounted for being similar to the American-Chinese complaints. This is because the Europeans argue that the value of the yen is devalued making the Japanese products in Europe cheaper. This affects the domestic firms in Europe as demand for cheaper products rises.
4. If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
• In the future the value of the RMB will rise significantly as demand for Chinese products in American will rise due to the cheap prices. But at the same time this will also create problems as exports from China will decrease as the price will increase causing Americans to reduce their purchase of Chinese products.
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@ Haleigh Eppler
Your answers are very well written. I do agree that the Europe and Japan situation is similar to the American and Chinese situation but with how much America already has, such as resources and raw materials do you think they are going to reduce exports and increase imports? Won’t they still continue to trade as much as they were trading now.
Good answers though
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1. What are the shortcomings of the Big Mac Index in depicting the true under or over-valuations of various currencies.
The taxes, the cost of prodution are taken into account. Since each country has different capital reasources, the cost of prodution becomes various. Moreover, different currincies are also shortcomings of Big Mac Index.
2. How has China intervened in currency markets to maintain the value of the RMB at such a low level?
Since China’s level of import is much lower than level of exports therefore the RMB is low.
3. What are two likely complaints the Europeans have against the value of the Japanese Yen? Are these similar to the complaints the US has against China?
Since the Japanese Yen is very cheap, the Europeans might argue that the Japanese takes the advantage of it and keep their export costs low. The US has similar complaints against China because Yen is undervalued against euro.
4. If the Chinese were to halt all interference in the currency markets, what do you think would happen to the value of the RMB? How would this affect the balance of trade between the US and China?
The value of RMB will appreiates which means produts of China will beome expensive too. Since China produts has less demand, exports will decrease. As a result of this, foreign investments will decrease in China and the fact of high value of Money, inflation may happen.
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