The Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries.
Here is something that I put together using the the Big Mac index from The Economist website. Students have to complete the table below and answer the questions that follow. It makes for a good discussion of PPP amongst countries
The Big Mac Index – January 2018
* Estimated figures
1. Complete the table above. In which country was their actual exchange rate on January 2018 closest to their Big Mac exchange rate?
2. Which country’s currency is suggested by your calculations above as being
a) the most undervalued against the dollar, and
b) the most overvalued against the dollar?
3. What factors could have an influence on exchange rate values on a given date as shown in the table above?
4. Differences in the prices of hamburgers could exist in the real world for a number of reasons. Suggest one reason relating to a) supply and b) demand which could lead to apparent deviations from equilibrium exchange rate values.
The Economist first compared the price of a McDonald’s Big Mac in a number of countries in 1986. It regarded the long-established Big Mac as the perfect universal commodity now produced locally in sixty-six countries. If the prices of a Big Mac in several countries in local currencies were expressed in dollars using the exchange rate, then it would be possible to see whether exchange rates do equalize the prices of an identical commodity such as a Big Mac. It is evident that a dollar does not buy the same amount in each of these nine countries. The question arises as to whether the exchange rate between the dollar and the currency of each of the countries shown below moves in the long run to equalize prices of an identical product such as a Big Mac. Some economists think this is the case.
From the data currently the $NZ is undervalued by 1%. How does it work?
In January 2013 a Big Mac in the USA was US$4.37.
In New Zealand it was NZ$5.20
Therefore the exchange rate for Big Mac’s = 5.20/4.37 = US$1 = NZ$1.19
The actual exchange rate at the time was US$1 = NZ$1.20
Big Mac index is 1% undervalued.
But differences in the prices of hamburgers could exist in the real world for a number of reasons which could lead to apparent deviations from equilibrium exchange rate values. This relates to:
If beef production is subsidised in some countries more than others, then this could be expected to affect local prices of a Big Mac. There could also be differences in the tariffs on beef imports in different countries. Furthermore other costs regarding bread and salad could also impact on
Beef may not be a suitable commodity to compare relative prices where, for religious reasons say, it is not regarded as an appropriate main item of diet.
Click below to go to the interactive graph.
Economist Big Mac Index