Big Mac Index, Big Mac Purchasing Power Parity
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The Big Mac Index provides a measure of purchasing power parity (PPP) between two currencies in an informal way. Introduced by Pam Woodall in 1986, the Big Mac Index is based on the purchasing-power parity (PPP) theory. This theory statesthat exchange rates around the world adjust to equalize the price of a basket of goods and services. The basket referred to by this index is a burger: a McDonald’s Big Mac.
The Big Mac Index provides a measure of purchasing power parity (PPP) between two currencies in an informal way. Introduced by Pam Woodall in 1986, the Big Mac Index is based on the purchasing-power parity (PPP) theory. This theory statesthat exchange rates around the world adjust to equalize the price of a basket of goods and services. The basket referred to by this index is a burger: a McDonald’s Big Mac.
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How does the Big Mac Index work?
The Index measures the price of a McDonald’s Big Mac burger in 31 countries. For example, the average price of a Big Mac in the US is $2.50 and the same is priced at $2.00 in Mexico. This shows that the Big Mac is 25% more expensive in the US compared to Mexico.
Advantages of Big Mac Index
The McDonald’s Big Mac is available across many countries around the world, with local McDonald’s franchises that can negotiateinput prices. This enables a comparison between currencies of many countries. The Index has a good track record of predicting thedirection of currencies, which can be used as a measure of inter-country wage differences.
Note that all the ingredients of the Big Mac are widely consumed in most countries as it includes bread, meat, cheese and tomato. This itself can be used as a reasonable proxy for a ‘Market Basket’ for wage earners. The Big Mac Index is simple tounderstand, consistent and timely.
Limitations of Big Mac Index
The Big Mac Index theory states that exchange rates across the world should simply even out the prices of Big Macs that are sold all around the world. However, this is not always applicable as it can be shared only between those countries that are facing a similar stage of development. In some countries, the social status of fast food also alters the demand for Big Macs.
The Big Mac Index is also distorted by transport costs, taxes, labor laws, levels of competition, and trade barriers betweenthe countries. It may be inconclusive as there are many countries which show lack of demand for Big Macs in developing countries.
Despite the limitations, the way the Big Mac Index works is noteworthy as a straight forward method of comparison, which evenlaypersons can understand.
