Part 1
Purchasing power parity is an economic theory that compares the purchasing power of different currencies in the world. It is applicable when one to purchase goods or services of the same amount in different countries. So, the cost of purchasing a Big Mac in the U.S is the same as that of China when the purchasing power parity holds. To calculate the cost of Big Mac in China, one will convert the cost of the Big Mac in the U.S into RMB, as shown below:
If $1 = 6.512 RMB, what about $5.30=?
The cost in China= $5.30× 6.512RMB/$1
=34.5136 RMB
The cost of the Big Mac in China is 34.5136 RMB when the purchasing power parity holds.
Part 2
The implied dollar price is calculated as follows;
The actual price in China is 20RMB, 1$=6.512 RMB
The implied dollar price= 20RMB/6.512RMB= $3.071
The dollar price implied by the PPP when the actual price of the Big Mac in China is 20RMB is $3.071.
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The implied price is the price that has been standardized to allow people to buy goods or services from different countries at the same amount using different currencies. However, the implied price may overvalue or undervalue the cost of some products or services within a given country. The implied price also helps buyers to identify the countries where they can get goods at a lower price. Moreover, the implied price is used by several government agencies to set standard prices for their products. The actual price is the price of a particular item in a given country. The exact amount differs from one country to another, depending on their economy and currency strength.
