Author Question: Define the price elasticity of demand and show how it is calculated. What will be an ideal ... (Read 47 times)

saliriagwu · **on:** Jun 29, 2018

Define the price elasticity of demand and show how it is calculated.

What will be an ideal response?

Question 2

The Big Mac Theory of Exchange Rates tests the accuracy of purchasing power parity theory. In July 2015, The Economist reported that the average price of a Big Mac in the United States was 4.79.

In Switzerland, the average price of a Big Mac at that time was 6.50 Swiss francs. If the exchange rate between the dollar and the Swiss franc was 0.93 Swiss francs per dollar, explain how it would be profitable to buy Big Macs in the United States instead of in Switzerland.

chloejackso · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

The price elasticity of demand is units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same. It equals the absolute value (or magnitude) of the ratio of the percentage change in the quantity demanded to the percentage change in the price. The percentage change in quantity (price) is measured as the change in quantity (price) divided by the average quantity (price).

Answer to Question 2

If a Big Mac costs 6.50 Swiss francs in Switzerland, a person in Switzerland could trade in that 6.50 Swiss francs for 6.99 (6.50 Swiss francs / 0.93 Swiss francs per dollar) and buy 6.99 / 4.79 = 1.46 Big Macs in the United States. Those 1.46 Big Macs could then be sold in Switzerland for 6.50 Swiss francs each, generating 1.46 Big Macs 6.50 Swiss francs per Big Mac = 9.49 Swiss francs. This implies that a person in Switzerland could profit by trading in Swiss francs for dollars, buying Big Macs in the United States, and reselling those Big Macs in Switzerland.