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Hungry for an Economics Lesson?

April 23, 2019

Posted in Economics

True confession: I almost failed economics in college. Creating graphs with colored pencils was the most interesting part of the class and unfortunately, I didn’t get credit for wide range of color usage. I feel like I would have succeeded a lot more if all the concepts taught were around food items, like the Big Mac Index. Talk about a fun way to break down a complex topic like exchange rates. Let’s look…

The Big Mac Index is published by The Economist as an informal (and fun) way of measuring purchasing power parity (PPP) between two countries. When two countries have PPP, people pay the same amount for an identical basket of goods and services (in this case, a burger). Any changes in exchange rates between nations would be seen in the price change of the Big Mac.

Composed of seven ingredients, the double-decker sandwich is produced in nearly identical fashion across more than 36,000 restaurants in over 100 countries.

In theory, the price of a Big Mac reflects a number of local economic factors, ranging from the cost of the ingredients to the cost of local production and advertising. So, the resulting PPP metrics is considered by many economists to be a reasonable measurement of real-world purchasing power.

How the Big Mac Index Works

The Big Mac Index is calculated by dividing the price of a Big Mac in one country by the price of a Big Mac in another country in their respective local currencies to arrive at an exchange rate. This exchange rate is then compared to the official exchange rate between the two currencies to determine if either currency is under or overvalued according to PPP theory.

In Russia, for example, a Big Mac costs 110 rubles ($1.65), compared with $5.58 in America. That suggests the ruble is undervalued by 70% against the dollar. In Switzerland, McDonald’s customers have to pay SFr6.50 ($6.62), which implies that the Swiss franc is overvalued by 19%. So if you’re contemplating some upcoming travel, and want to buy your fast food on a budget, your money will go much further in Russia than Switzerland.

The Secret Sauce

Consistency is the secret sauce of the Big Mac Index, which is why this lighthearted view of purchasing power has  become a global standard, included in several economic textbooks (although if it was in mine, I don’t remember). While the idea of “burgernomics” was never intended to be a precise gauge of currency misalignment, we think it makes exchange-rate theory more digestible (pun intended).



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