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Chapter 10. What Moves the Markets: Basi... > Equilibrium: “Parity”

Equilibrium: “Parity”

Many different theories all roughly state that costs, services, and trade must be brought into balance. If they are not, the country's currency will rise or fall to find equilibrium. The Economist maintains what it calls the “Big Mac index.” It compares the price of a Big Mac in dozens of different countries to determine if their currency is undervalued or overvalued. If a Big Mac costs $2 in New York and one euro in Paris, the currency exchange rate should be one euro = $2. If the currencies are being traded at $1.50 for one euro, the dollar is said to be overvalued and the euro undervalued. Eventually, according to this theory, the dollar will grow weaker and the euro stronger to make up this difference. This is also known as the “purchasing power parity” theory.


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