Big-Mac-Index

The Big Mac Index compares prices of the Big Mac in different currencies of the world. Through the conversion of domestic currency at the current U.S. dollar exchange rate, they are compared with each other with a simplistic method.

The Big Mac is a simple indicator of the purchasing power of a currency, since it gives him almost everywhere in the world in standardized size, composition and quality.

History

The index was published by the British weekly The Economist in 1986 for the first time and is collected regularly since then. Was developed, the index of the editor Pam Woodall, as a journalist for the Asian economy for The Economist is still working today. Using the Big Mac index, the journal wanted to make not only the issue of exchange rates and purchasing power parity exchange rate easily understood, but also show positive and negative evaluations of individual currencies.

Conceptual framing

The Economist developed the index as a price comparison and comparison of purchasing power among countries. The basis for this has one of the oldest considerations of international macroeconomics: the purchasing power parity (PPP, English:. Purchasing power parity, PPP), which was developed among others by David Ricardo and other British economists of the 19th century.

Law of one price and purchasing power parity

The basis of the purchasing power parity theory provides the law of one price. It states that a homogeneous good in two different countries has no price differences, as long as a perfect market exists. This implies among other things that complete free trade between the countries and it is (for example in the form of transport and insurance costs) are no transaction costs.

In a homogeneous good which after conversion has in the country 1 and country 2 using the current exchange rate in a single currency price differences, taking advantage of price differences between countries leads ( arbitrage ) for the realization of the law of one price for homogeneous goods. This means that the goods are bought cheaper in one country and sold at a profit -maximizing in another country. This arbitrage has the effect that the goods are sold as long as profit-maximizing in the importing country, to the price of these goods falls on the actual price level of the exporting country.

Transfer to a multi - goods case we speak of purchasing power parity, if the purchasing power of two currencies, as measured by an index of various commodity prices, is the same.

Joint purchasing power exchange rate

The purchasing power parity exchange rate is the one (hypothetical) exchange rate at which the real prices of goods in the two currency areas under consideration correspond to a uniform price level. Consequently, the actual exchange rate should adjust the PPP rate over the long term. In formulaic terms, this means:

, where

• The price of a given basket of goods in the domestic and
• Is the price of the corresponding basket of goods abroad and
• The nominal exchange rate between the two countries, expressed as is.

For example, if a liter of Coca -Cola in Europe costs an average of 2.50 euros and dollars in the U.S. an average of 1.60, so the PPP would be good for this homogeneous between Europe and the United States. In Europe 1.56 € must be paid for every dollar spent in the U.S. for a liter of Coca -Cola to get the same quantity and quality of this drink.

Definition and nature of the Big Mac index

In the case of the Big Mac index consists of the shopping cart of a single good, but which are available in over 140 countries, is the Big Mac of the restaurant chain McDonald's.

For over 40 years, the hamburger is because of strict conditions by franchises international standard almost everywhere the same ingredients: sesame buns, ground beef, cheese, lettuce, pickles, onions and sauce. For cultural reasons, other ingredients are used, as the example shows in India in some countries. While the Maharaja Mac coincides in form with the Big Mac, but it consists of, among other things: sesame bun, grilled chicken, lettuce, cheese and janchi sauce.

When raised by The Economist study the price of a Big Mac in different countries are collected in the domestic currency and are made comparable by conversion to the prevailing exchange rate at the time in U.S. dollars.

The Big Mac could also by the strategies of McDonald's to use local ingredients and to win well-known brand manufacturers as suppliers, reflecting the domestic purchasing power of an economy.

Numerical values

Über-/Unterbewertung a currency

Using the Big Mac prices represents those over-and under-valuation of the respective countries, the business magazine and would thus refute the thesis of the prevailing balance on the international currency market. Especially over-valued currencies are, consequently, the Swedish and the Norwegian krone and the Swiss franc. An over-or undervaluation is when local goods are more expensive or cheaper than equivalent goods abroad due to the current exchange rate.

The percentage ( x) of the Über-/Unterbewertung is therefore:

With

• : The nominal exchange rate of the domestic currency in U.S. dollars

If the price of a Big Mac is used alone as the calculation basis of a "fair" exchange rate, then the current price of the euro against the U.S. dollar on the foreign exchange market is valued at 16 % and the Swiss franc even to 66 %. Leader is in the last study (2010) of The Economist but Norway, overvalued by 93 %.

The price level represented by the Big Mac price is therefore in Sri Lanka and Ukraine, whose currencies are to be undervalued by about 50% against the U.S. dollar particularly favorable.

Critical review

The Big Mac index is only a very rough indicator to estimate purchasing power parities.

Exchange rates are determined in the short run not only from price trends and flows of goods, but also determined by currency speculation and interest rate differentials between currency zones, economic trends and political factors. So it is not possible an unambiguous representation of the purchasing power by converting the burger prices with the current exchange rate in the short run.

Even if the index is to be used for a long -term view, its significance is limited. While the Big Mac price is calculated as a simple measure for comparison of the usual national price levels. However, there are a number of factors that influence the price, can not be attributed to the local purchasing power. So the price is also determined by the regional differences in costs of hamburger production and to market conditions:

• Usual local procurement costs (transport )
• Labor costs
• Barriers to Trade
• Rent and energy costs
• Level of prosperity in a country
• Domestic demand
• Intensity of competition among fast-food restaurants in a country

Furthermore, the price of the location of the restaurant (airport, highway, downtown) is affected. The appreciation of the Big Mac is different beyond in the individual countries. Moreover, it is often cheaper to buy national dishes. Because of these factors is a Local pricing ( ie, sales of the Big Mac in different regions at different prices ) for the company a rational measure as part of its profit maximization.

Another crucial factor, which is why there is no world market price of Big Macs out forms, is the lack of marketability of the burger. If only it prevents arbitrage trading.

The Big Mac is also used in some countries not available for religious reasons, so in its place a similar product is used as a benchmark ( eg India). Due to the fact that those influenced by other factors Burger prices of the Big Mac index is based, can be objectively measured by the index, the purchasing power of currencies obviously not historical.