Question

uppose a Starbucks tall latte cost $4.00 in the United States, 5.00 euros in the euro area and $2.50 Australian dollars in Australia. Nominal exchange rates are .80 euros per dollar and 1.4 Australian dollars per U.S. dollar. Where does purchasing power parity hold

Answer 1

Answer: Nether Australia or Europe

Explanation:

Purchasing power parity is a notion that states that prices of the same or similar goods should have the same price across the world after adjusting for exchange rate differences.

If the price of a tall latte in the U.S. is $4,00, it should be the same price in Europe and Australia after exchange rate adjustments.

$4.00 in Euro is:                                                  $4.00 in Australian dollars is:

= 4 * 0.8                                                                 = 4 * 1.4

= €3.20                                                                 = $5.60

Purchasing power parity does not hold in wither countries because the prices of the lattes are not equal to the $4.00 in the U.S. after adjustments for exchange rates.