User:Tindrith/Big Mac index Project Desk



The Big Mac index is an informal measure of the theory of purchasing-power parity (PPP) and provides a test of the extent to which the exchange rate markets result in similar goods costing the same in different countries. As stated in the Economist, it "seeks to make exchange-rate theory more digestible."

Overview
The theory of purchasing-power parity (PPP) provides a method for predicting exchange rate movements whereby the theory states that the exchange rate between two currencies should naturally adjust such that a sample basket of goods should cost the same in both currencies when converted at the newly adjusted rate of currency exchange.

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 based on a common set of specification in many countries around the world. Further more local McDonald's franchisees have significant responsibility for negotiating input prices. For these reasons, the Big Mac index enables a comparison between many different countries' currencies.

History
The Big Mac™ index was introduced by The Economist newspaper in September of 1986 as a humorous illustration of the theory of purchasing-power parity (PPP) and has been published by that publication annually since. The creation of this index gave rise to the word burgernomics.

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Calculation of the Index
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 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 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 2.50/2.00 = 1.25. If, in fact, the US 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 price of the Big Mac in both countries (information as of 2005).

Similar Indices
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.

An interesting fact is that the student organisation BEST (Board of European Students of Technology) used the Big Mac index as a common currency until the appearance of the euro.