Big Mac Index Totally Explained

Everything about The Big Mac Index totally explained

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. As stated in The Economist, it "seeks to make exchange-rate theory a bit more digestible".

Overview

The Big Mac Index was introduced by The Economist in September 1986 as a humorous illustration and has been published by that paper annually since then. The index also gave rise to the word burgernomics.
One suggested method of predicting exchange rate movements is that the rate between two currencies should naturally adjust so that a sample basket of goods and services should cost the same in both currencies. In the Big Mac Index, the "basket" in question is considered to be a single Big Mac burger as sold by the McDonald's fast food restaurant chain. The Big Mac was chosen because it's available to a common specification in many countries around the world, with local McDonald's franchisees having significant responsibility for negotiating input prices. For these reasons, the index enables a comparison between many countries' currencies. Some menu items are market specific, which would hinder a comparison, if used. Still other menu items are specially priced, such as the dollar menu in many U.S. restaurants consisting of sandwiches and other items that cost $1.
The Big Mac PPP exchange rate between two countries is obtained by dividing the price of a Big Mac in one country (in its currency) by the price of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it's lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it's higher, then the first currency is over-valued.
For example, suppose the price of a Big Mac is $2.50 in the United States and £2.00 in the United Kingdom; thus, the PPP rate is £2.00/$2.50 = 0.80 pounds/dollar. If, in fact, £0.50 buys $1 (or £1 buys $2.00), then the dollar is under-valued by £0.30 (£0.80 - £0.50), or 38% (£0.30/£0.80) in comparison with the price of the Big Mac in both countries.

Variants

The Economist sometimes produces variants on the theme. For example in January 2004, it showed a Tall Latte index with the Big Mac replaced by a cup of Starbucks coffee. In a similar vein, in 1997, the newspaper drew up a "Coca-Cola map" that showed inverse proportionality between the amount of Cola consumed per capita in a country and that country's health.
In 2007, Australian bank, Commonwealth Securities, adopted the Big Mac index and created the iPod Index. The bank's theory is that since the iPod is manufactured at a single place, the value of iPods should be more consistent globally. Though this theory can be criticised for ignoring shipping costs, which will vary depending on how far the product is delivered from its "single place" of manufacture.

Limitations

The burger methodology has limitations in its estimates of the PPP. 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 isn't as large in countries like India as in the United States. Social status of eating at fast food restaurants like McDonald's, local taxes, levels of competition, and import duties on selected items may not be representative of the country's economy as a whole. In addition, there's no theoretical reason why non-tradable goods and services such as property costs should be equal in different countries: this is the theoretical reason for PPPs being different from market exchange rates over time. Nevertheless, the Big Mac Index has become widely cited by economists.

Figures (all prices in US Dollars)

Five most expensive

Iceland - US 7.44
Norway - US 6.63
Reunion Island - US 6.23
Switzerland - US 5.05
Denmark - US 4.84

Five most affordable

India - US 1.40

China - US 1.41

Hong Kong - US 1.54

Malaysia - US 1.57

Venezuela - US 1.58

Egypt - US 1.60Further Information

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