- The Big Mac index
The Economist published the Big Mac Index or Burgernomics in 1986 as an informal way to see whether the currency is under or overvalued. To understand the Big Mac Index, we first need to understand the theory of purchasing power parity (PPP).
What is Purchasing Power Parity (PPP)
- PPP is an economic theory that compares two different countries' currencies through a "basket of goods" approach
- If you really want to make a meaningful comparison of prices between two countries, you need to consider a wide range of goods and services
- PPP essentially compares hundreds of various goods and services that help economists estimate the global growth and productivity
- PPP is sometimes paired with Nominal Gross Domestic Product (GDP) because GDP on its own can get somewhat inaccurate due to currency manipulation. That's why GDP together with PPP, which is based on a basket of goods approach, can be a fairer comparison between countries
So What is The Big Mac Index Then?
- The Big Mac Index is inherently the theory of PPP but in this case, the basket of goods is a Big Mac. McDonald's has outlets in 119 countries out of a total of 195, the ingredients of the Big Mac are the same around the globe, only with slight deviations. Because of that, it serves as a convenient basket of goods
- The Big Mac index is calculated by dividing the local price of a Big Mac in one country by the local price of a Big Mac in another country.
- When compared to the official exchange, the Big Mac Index reflects which currencies are under or overvalued
- Take Malaysia and the US for example, A Big Mac costs RM10.40 in Malaysia and $5.66 in the US. The implied exchange rate is 1.84. The difference between this and the actual exchange rate, 4.11, suggests that the Malaysian ringgit is 56% undervalued
Although the Big Mac Index seems like a fun economic theory, it is not really a good reflection of reality. In reality, there are so many factors that have to be considered. E.g. Some ingredients are not available locally and must be imported, which results in transportation costs or the government of some countries implemented tariffs on certain imported goods. Hence, the same products in other countries will be relatively cheaper.
Having said that, I think that the Big Mac Index would be useful when we go travelling to other countries so that we can have a gauge of how expensive the food in that country is going to be.