Chapter 14. The Big Mac Index

14.1 Section Title

Chapter 14 HEADLINE: The Big Mac Index

A photo shows McDonalds logo in China. The name board has the brang logo with the brand name Mc Donalds written in english and Chinese.
AP Photo/Greg Baker
Home of the undervalued burger?

For more than 25 years, The Economist newspaper has engaged in a whimsical attempt to judge PPP theory based on a well-known, globally uniform consumer good: McDonald’s Big Mac. The over- or undervaluation of a currency against the U.S. dollar is gauged by comparing the relative prices of a burger in a common currency, and expressing the difference as a percentage deviation from one:

[MATH: \text{Big Mac Index}=q^{\text{BigMac}}-1=\left(\frac{E_{\$/\text{local currency}}P^{\text{Big Mac}}_{\text{local}}}{P^{\text{Big Mac}}_{\text{US}}}\right)-1](big mac index shows normalized difference between cost of big mac in some country and u.s. which equal to exchange rate to u.s. multiplied by cost of big mac in local restaurant divided by cost of big mac in u.s. minus normalized cost of big mac in united states)

Table 14-1 shows the July 2012 survey results, and some examples will illustrate how the calculations work. Row 1 shows the average U.S. dollar price of the Big Mac of $4.33. An example of undervaluation appears in Row 2, where we see that the Buenos Aires correspondent found the same burger cost 19 pesos, which, at an actual exchange rate of 4.57 pesos per dollar, worked out to be $4.16 in U.S. currency, or 4% less than the U.S. price. So the peso was 4% undervalued against the U.S. dollar according to this measure, and Argentina’s exchange rate would have had to appreciate to 4.39 pesos per dollar to attain the level implied by a burger-based PPP theory. An example of overvaluation appears in Row 4, in the case of neighboring Brazil. There a Big Mac cost 10.08 reais, or $4.94 in U.S. currency at the prevailing exchange rate of 2.04 reais per dollar, making the Brazilian burgers 14% more expensive than their U.S. counterparts. To get to its PPP-implied level, and put the burgers at parity, Brazil’s currency would have needed to depreciate to 2.33 reais per dollar. Looking through the table, burger disparity is typical, with only 7 countries coming within ±5% of PPP.

Big Mac Prices Exchange rate (local currency per U.S. dollar) Over(+)/under(-) valuation against dollar, %, (5)
In local currency (1) In U.S. dollars (2) Implied by PPP (3) Actual, July 25th (4)
United States $ 4.33 4.33 - - -
Argentina Peso 19 4.16 4.39 4.57 -4
Australia A$ 4.56 4.68 1.05 0.97 8
Brazil Real 10.08 4.94 2.33 2.04 14
Britain £ 2.69 4.16 0.62 0.65 -4
Canada C$ 3.89 3.82 0.90 1.02 -12
Chile Peso 2050 4.16 473.71 493.05 -4
China Yuan 15.65 2.45 3.62 6.39 -43
Colombia Peso 8600 4.77 1987.29 1804.48 10
Costa Rica Colones 1200 2.40 277.30 501.02 -45
Czech Republic Koruna 70.33 3.34 16.25 21.05 -23
Denmark DK 28.5 4.65 6.59 6.14 7
Egypt Point 16 2.64 3.70 6.07 -39
Euro area € 3.58 4.34 0.83 0.83 0
Hong Kong HK$ 16.5 2.13 3.81 7.76 -51
Hungary Forint 830 3.48 191.80 238.22 -19
India Rupee 89 1.58 20.57 56.17 -63
Indonesia Rupiah 24200 2.55 5592.00 9482.50 -41
Israel Shekel 11.9 2.92 2.75 4.08 -33
Japan Yeo 320 4.09 73.95 78.22 -33
Latvia Lats 1.69 2.94 0.39 0.57 -32
Lithuania Litas 7.8 2.74 1.80 2.85 -37
Malaysia Ringgit 7.4 2.33 1.71 3.17 -46
Mexico Peso 37 2.70 8.55 13.69 -38
New Zealand NZS 5.1 4.00 1.18 1.27 -7
Norway Kroner 43 7.06 9.94 6.09 63
Pakistan Rupee 285 3.01 65.86 94.61 -30
Philippines Peso 118 2.80 27.27 42.20 -35
Poland Zloty 9.1 2.63 2.10 3.46 -39
Russia Rouble 75 2.29 17.33 32.77 -47
Saudi Arabia riyal 10 2.67 2.31 3.75 -38
Singapore S$ 4.4 3.50 1.02 1.26 -19
South Africa Rand 19.95 2.36 4.61 8.47 -46
South Korea Won 3700 3.21 855.00 1151.00 -26
Sri Lanka Rupee 290 2.21 67.01 131.00 -49
Sweden SKr 48.4 6.94 11.18 6.98 60
Switzerland SFr 6.5 6.56 1.50 0.99 52
Taiwan NT$ 75 2.48 17.33 30.20 -43
Tailand Baht 82 2.59 18.95 31.70 -40
Turkey Lira 8.25 4.52 1.91 1.83 4
UAE Dirhams 12 3.27 2.77 3.67 -25
Ukraine Hryvnia 15 1.86 3.47 8.09 -57
Uruguay Peso 99 4.53 22.88 21.87 5
Venezuela Bolivar 34 7.92 7.86 4.29 83

Source: © The Economist Newspaper Limited, London (July 26, 2012). Actual market exchange rates are for July 25, 2012. PPP-implied rate is local currency price divided by price in United. States. The U.S. price is average of four cities; China price is average of five cities; Euro area price is weighted average of prices in euro area; India price is the price of a Maharaja Mac.

Question 1

Question

Looking at the above data: In Table 14-1 what similarities do you notice in the countries with the most overvalued or undervalued exchange rates?

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The countries with the most overvalued exchange rates are Venezuela, Norway, Sweden, and Switzerland. The latter three countries are often considered to have a high cost of living. Furthermore, these countries were relatively unscathed by the Global Financial Crisis. The countries with the most undervalued currencies are India, Ukraine, Hong Kong, Sri Lanka, and Russia. These countries have relatively large ratios of trade to GDP ratios. As you can see, however, there is no universal characteristic of a country that has an over/undervalued exchange rate.

Question 2

Question

Given the price differentials in the table, what do you think will happen to exchange rates in the long run?

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One would expect overvalued currencies to depreciate relative to undervalued currencies.

Question 3

Question

In terms of the purchasing power parity theory discussed in the chapter, why do prices differ across countries? Why might the price of a Big Mac differ so much between Mexico and the United States? What about the euro area and other European countries, such as Sweden, Switzerland, and Norway?

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The book talks about transactions costs, nontraded goods, imperfect competition and legal obstacles, and price stickiness. The Big Mac is likely to be a nontradable good (it wouldn’t taste too good after its trip across the border). However, a later Headline, The Curry Trade, shows that many people are finding ways to transport food if the price differential is large enough.

Question 4

Question

The website www.bigmacindex.org has historical data for the Big Mac Index. Pick a country and analyze the Big Mac Index over time. Do you observe convergence to purchasing power parity? Does purchasing power parity hold?

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One could select any of a number of countries, but if PPP does hold in the long run, we would expect overvalued currencies to depreciate over time and undervalued currencies to appreciate.

Question 5

Question

If you have had the opportunity to travel abroad, can you think of any items whose real prices differed significantly from those in the United States?

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This is an open-ended question, but one could focus on Starbucks coffee, Coke and Pepsi, or apparel items that are commonly found in several countries.