Big Mac index

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Image:BigMacAustralia.jpg 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.

The Big Mac index was introduced by The Economist newspaper in September 1986 as a humourous illustration and has been published by that paper more or less 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 as sold by the McDonald's fast food restaurant chain. The Big Mac was chosen because it is 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.

The Big Mac PPP exchange rate between two countries is obtained by dividing the cost of a Big Mac in one country (in its currency) by the cost of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.

For example, suppose a Big Mac costs $2.50 in the United States and £2.00 in the United Kingdom; thus, the PPP rate is 2.50/2.00 = 1.25. If, in fact, the dollar buys £0.55 (or £1 = $1.81), then the pound is over-valued (1.81 > 1.25) with the respect to the dollar by 44.8% in comparison with the costs of the Big Mac in both countries (information as of 2005).

In January 2004, The Economist introduced a sister Tall Latte index. The idea is the same, except that the Big Mac is replaced by a cup of Starbucks coffee, acknowledging the global spread of that chain in recent years. In a similar vein, in 1997, the newspaper drew up a "Coca-Cola map" that showed a strong positive correlation between the amount of Coke consumed per capita in a country and that country's wealth.

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 is not as large in countries like India as in the United States. Whereas low income Americans may eat at McDonald's a few times a week, low income Malaysians probably never eat Big Macs. Social status of eating at fast food resturants like McDonald's, local taxes, levels of competition, and import duties for burgers may not be representative of the country's economy as a whole. In addition, there is no theoretical reason why non-tradable goods and services such as property costs should be equal in different countries. Nevertheless, the Big Mac index has become widely cited by economists.

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External links

es:Índice Big Mac fr:Indice Big Mac ko:빅맥 지수 it:Indice Big Mac nl:Big Mac-index ja:ビッグマック指数 sv:Big Mac-index zh:巨無霸指數

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