Big Mac Index

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Big Mac Index

  1. 1. In September 1986, Pam Woodall introduced, in The Economist , one of the most unusual economic measures known to man! That measure is…
  2. 2. The ‘ Big Mac’ Index
  3. 3. More detail By definition: The Big Mac Index is an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries. The name Big Mac comes from the Big Mac hamburger sold at McDonald's.
  4. 4. As mentioned before, the index is based on the theory of purchasing-power parity , the notion that a dollar should buy the same amount in all countries. Thus in the long run, the exchange rate between two countries should move towards the rate that equalises the prices of an identical basket of goods and services in each country.
  5. 5. The Big Mac was chosen because it is available to a common specification in many countries around the world, with local McDonald's franchises having significant responsibility for negotiating input prices. For these reasons, the index enables a comparison between many countries' currencies.
  6. 6. “ it seeks to make exchange-rate theory a bit more digestible.” - The Economist To understand how to obtain the Index, we’ll use an example for the prices of a Big Mac last July in the UK and the USA: <ul><li>the price of a Big Mac was $3.57 in the United States </li></ul><ul><li>the price of a Big Mac was £2.29 in the United Kingdom (Britain) </li></ul><ul><li>the implied purchasing power parity was $1.56 to £1, that is $3.57/£2.29 = 1.56 </li></ul><ul><li>this compares with an actual exchange rate of $2.00 to £1 at the time </li></ul><ul><li>the pound was thus overvalued against the dollar by 28% </li></ul><ul><ul><li>ie the actual exchange rate divided by implied purchasing parity </li></ul></ul><ul><ul><ul><ul><ul><li>-> 2 divided by 1.56 = 1.28 </li></ul></ul></ul></ul></ul>
  7. 7. This is the Index from 4th February 2009.
  8. 8. The Advantages of The ‘Big Mac’ Index are that: <ul><li>Since it’s creation, it has a good track record in predicting the direction of currencies. </li></ul><ul><li>The index still offers significant insight and an easy to understand example of PPP. </li></ul>
  9. 9. The Limitations of The ‘Big Mac’ Index are that: <ul><li>“… the Big Mac index can be distorted by taxes, transport costs, labour laws and trade barriers in each country.” - Craig James, Commonwealth Securities chief economist </li></ul><ul><li>In many countries, eating at international fast-food chain restaurants such as McDonald's is relatively expensive in comparison to eating at a local restaurant, and the demand for Big Macs is not as large in countries like India as in the United States. </li></ul>

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