Big Mac index

3 key takeaways

• The Big Mac index compares the price of a Big Mac burger across various countries to determine whether currencies are undervalued or overvalued.
• It provides a simple and relatable method to understand the concept of purchasing power parity.
• The index highlights the differences in cost of living and economic conditions between countries.

What is the Big Mac index?

The Big Mac index was introduced by The Economist magazine in 1986 as a lighthearted way to illustrate purchasing power parity (PPP) between different currencies. PPP is an economic theory that states that in the long run, exchange rates should move towards the rate that equalizes the prices of an identical basket of goods and services in any two countries. The Big Mac, being a standardized product sold globally, serves as a useful benchmark for this comparison.

By comparing the price of a Big Mac in various countries, the index shows whether a currency is overvalued or undervalued relative to the US dollar. If a Big Mac costs significantly more in one country than in the United States, the local currency is considered overvalued. Conversely, if it costs less, the currency is deemed undervalued.

How does the Big Mac index work?

The Big Mac index works by comparing the local price of a Big Mac with its price in the United States, converted to US dollars using the current exchange rate. The steps involved are:

1. Collect Price Data: Obtain the price of a Big Mac in different countries.
2. Convert Prices: Convert these prices into US dollars using the current exchange rates.
3. Calculate PPP: Determine the implied PPP by dividing the local price by the US price.
4. Compare to Exchange Rates: Compare the implied PPP to the actual exchange rate. If the implied PPP is higher than the actual exchange rate, the local currency is undervalued; if lower, it is overvalued.

Example Calculation:

• Price of Big Mac in the US: $5.00
• Price of Big Mac in Country X: 30 units of local currency
• Current Exchange Rate: 1 USD = 6 units of local currency
• Price in USD: 30 / 6 = $5.00

If the price in Country X, after converting to USD, is significantly higher or lower than $5.00, it indicates whether the currency is overvalued or undervalued.

Real world application

The Big Mac index serves as a simple tool to understand complex economic concepts and to compare currency values across different countries. While it is not a precise measure of exchange rates or cost of living, it offers a quick and accessible way to gauge whether a currency might be under or overvalued.

For example, in 2021, The Economist found that the Swiss franc was overvalued because the price of a Big Mac in Switzerland was significantly higher than in the United States after converting to USD. Conversely, the Russian ruble was found to be undervalued as the price of a Big Mac in Russia was much lower than in the United States after conversion.

Related topics

If you are interested in learning more about economic indicators and currency comparisons, consider exploring these topics:

• Purchasing Power Parity (PPP): A deeper look into the economic theory behind the Big Mac index.
• Exchange Rates: Understanding how exchange rates are determined and their impact on the economy.
• Cost of Living Index: Comparing the cost of living in different countries and cities.
• Globalization and Trade: How global trade and economic policies influence currency values and purchasing power.

These related topics provide a broader understanding of how currencies are valued and compared, helping you grasp the complexities of global economics in a more intuitive way.