The Big Mac index was invented by the Economists in 1986 as a guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services (in this case, a burger) in any two countries.
For example, using figures in July 2008:
the price of a Big Mac was $3.57 in the United States (varies by store)
the price of a Big Mac was £2.29 in the United Kingdom (varies by region)
the implied purchasing power parity was $1.56 to £1, that is $3.57/£2.29 = 1.56
this compares with an actual exchange rate of $2.00 to £1 at the time
(2.00–1.56)/1.56 = 28%
the Pound was thus overvalued against the Dollar by 28%
The index was developed based on Correlation analysis between the price of the burger and average hourly wages in that country – the price of Big Mac depends on the average hourly wages in a country which impacts the PPP.
Read the article available under Module 5 (What the Big Mac index tells you about currency wars) and answer the following questions:
Do you think this is a precise gauge for currency misalignment? Why or Why Not?
Do you think the average burger prices to be cheaper in poor countries than rich countries because labor costs are lower?
What else do you conclude from this article?
Please comment on other’s postings.
