 |  International Business : The Challenge of Global Competition, 8/e Donald Ball
Wendell H. McCulloch,
California State University Long Beach
Paul L. Frantz,
California State University Long Beach
Michael Geringer,
California Polytechnic State University
Michael S. Minor,
University of Texas Pan American
Understanding the International Monetary System
Internet AssignmentsStudents: Included here are some internet/case assignments that you can use to review
or that your instructor may give as assignments. Your instructors have been
given the answers to these questions and may choose to give them out to you
or not.
This case is designed to:
- Provide more information about the Big Mac Index published annually by The
Economist;
- Further explain the economic concept of purchasing power parity; and
- Relate both the Big Mac Index and purchasing power parity to an international
business setting.
In 2000, you were involved in negotiations with a company in Japan to purchase
machine parts. The price that had been agreed upon was $500,000, with payment
to the Japanese company in US dollars. Because of personnel changes in your company,
the negotiations were never completed. Things have now settled down and your task
is to complete the negotiations. You wonder, however, whether $500,000 will buy
as many parts today as it would in 2000.
You remember reading about the Big Mac Index in your university course in international
business. The Economist has published this index every year since 1986.
You recall that this index offers a somewhat humorous view of the relationships
of different currencies to the US dollar. It utilizes the economic concept of
purchasing power parity (PPP). Under PPP, currency exchange rates should bring
different currencies into equilibrium with one another. The result is an equalizing
of the price of a basket of goods and services across all countries. That is,
the cost of a basket of goods in the United States should be the same as the cost
of the same basket of goods in Japan if PPP is achieved.
To make the PPP notion more meaningful, The Economist replaced the "basket
of goods and services" notion with one product that is universally known.
That product is McDonald's Big Mac. With the Big Mac, The Economist computed
the Big Mac PPP. The Big Mac PPP is the exchange rate that would result in a Big
Mac costing the same in the US as in other countries. The Big Mac PPP is then
compared to the actual exchange rate to determine the under-valuation or over-valuation
of different currencies with the US dollar. The chart below shows information
about Japan from the Big Mac Index published in the April 27, 2000.
| Country | Big Mac prices in local currency | Big Mac prices in dollars | Implied PPP of the dollar | Actual $ exchange rate 4/25/00 | Under (-) /over (+) valuation against the dollar,
% | | US | $2.51 | 2.51 | | | | | Japan | ¥294 | 2.78 | 117 | 106 | +11 |
The 2.78 Big Mac price in dollars is computed by taking the Japanese price of
¥294 and dividing it by the exchange rate of 106 (294/106=2.78). The 117
implied purchasing power parity of the dollar is computed by dividing the Big
Mac price of ¥294 by the $2.51 American price (294/2.51=117). Finally, the
11% over-valuation of the Yen against the dollar is computed by dividing the difference
between the implied PPP of 117 and the actual exchange rate of 106, by the actual
exchange rate of 106 [(117-106)/106=11].
Therefore, you know that when the original negotiations were taking place, the
Japanese Yen was over-valued by 11% when compared to the US dollar, at least according
to the Big Mac index.
Case Instructions:
To prepare for the resumed negotiations, you need to answer the following questions?
- Is the Big Mac really a universal product? To answer this question, go here
http://www.mcdonalds.com/countries/index.html
to see in how many countries McDonalds has restaurant locations?
- What exactly does it mean to say that the Japanese Yen is overvalued by
11% against the US dollar? Go here to find out.
http://www.economist.com/library/focus/displayStory.cfm?story_id=305167;amp;CFID=1040769;amp;CFTOKEN=24227365- What is the current US dollar exchange of the Japanese Yen? Check the xe.com
Universal Currency Converter at http://www.xe.net/ucc/
to find out.
- Assuming that prices of the Big Mac have been stable in both the US and
Japan, use the exchange rate that you determined in number 3 above and compute
the amount by which the Japanese Yen is either over-valued or under-valued
against the dollar.
- Given your answer to number 4, would the $500,000 price buy the same amount,
more or fewer goods today than in 2000?
- Based on your answer to number 5, should you re-negotiate the price? Why
or why not?
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2002 McGraw-Hill Higher Education