(b) As mentioned in class, the Big Mac Index is a numerical tool for assessing disparities in consumer purchasing power between countries. Suppose that the Big Mac costs 7.50 Canadian dollars in Canada and 5.50 US dollars in the US. Suppose that the price of 1 Canadian dollar in terms of US dollars is 0.8 US dollars (note that the nominal exchange rate is defined in terms of the price of foreign currency (US) per unit of domestic currency (Canadian).

(i) Calculate the price of the Big Mac in Canada in US dollars and compare with the price of the Big Mac in the US in US dollars. Is the Big Mac cheaper in Canada or the US? Is this consistent with the Law of One Price?

(ii) Calculate the Big Mac exchange rate (in terms of US dollars per Canadian dollar

(iii) Calculate the real exchange rate using the formula indicated in the book and PowerPoint slides.

(iv) Is the US dollar undervalued or overvalued against the Canadian dollar? If so by how much (in %)?

(v) What are the limitations of having an undervalued currency>