Big mac index

What Is the Big Mac Index?

The Big Mac Index is an informal measure created by The Economist magazine that compares the relative cost of a McDonald's Big Mac burger across various countries to provide a lighthearted illustration of Purchasing Power Parity. It belongs to the broader category of International Economics, offering a simplified glimpse into currency valuation and global price level differences⁴³. The premise of the Big Mac Index is that, due to the standardization of the Big Mac burger across the globe, its price should be roughly equivalent in any two countries when expressed in a common currency, if exchange rates were truly in equilibrium. Any significant deviation suggests that one currency may be overvalued or undervalued relative to another.

History and Origin

The Big Mac Index was conceived by Pam Woodall and first published by The Economist in September 1986⁴². Its creation was intended as a semi-humorous, yet insightful, way to make the complex economic theory of Purchasing Power Parity (PPP) more "digestible" to a wider audience⁴⁰, ⁴¹. The idea stemmed from the observation that McDonald's Big Mac hamburgers are produced with largely similar ingredients and processes worldwide, making them an ideal single-good "basket" for price comparison³⁹.

Despite its informal beginnings, the Big Mac Index quickly gained widespread recognition and has since been featured in numerous academic textbooks and reports globally³⁸. Over the years, The Economist has continued to publish the index bi-annually, offering regular updates on global currency valuations and influencing discussions on international economic conditions³⁶, ³⁷.

Key Takeaways

• The Big Mac Index is an informal gauge of Purchasing Power Parity between currencies, using the price of a McDonald's Big Mac burger.
• It helps illustrate whether a currency is undervalued or overvalued against a base currency, typically the U.S. dollar.³⁵
• The index was introduced by The Economist in 1986 to simplify complex exchange rate theory.³⁴
• While not a precise academic tool, it provides a practical, real-world approximation of relative Cost of Living and economic indicators.³³
• Limitations include differences in local production costs, taxes, and non-tradable inputs like rent and labor, which can affect burger prices beyond pure currency valuation.³²

Formula and Calculation

The Big Mac Index calculates an implied exchange rate between two currencies based on the price of a Big Mac in each country. This implied rate is then compared to the actual market exchange rate to determine if a currency is overvalued or undervalued.

The formula for the implied Purchasing Power Parity (PPP) exchange rate is:

$\text{Implied PPP Exchange Rate} = \frac{\text{Price of Big Mac in Country A (in its currency)}}{\text{Price of Big Mac in Country B (in its currency)}}$

To calculate the over or undervaluation of a currency (Currency A) against a base currency (Currency B, typically the U.S. dollar), the formula is:

$\text{Over/Undervaluation of Currency A} = \left( \frac{\text{Implied PPP Exchange Rate}}{\text{Actual Market Exchange Rate}} - 1 \right) \times 100\%$

A positive percentage indicates overvaluation, while a negative percentage indicates undervaluation³¹. The Market Price of the Big Mac is central to this calculation.

Interpreting the Big Mac Index

Interpreting the Big Mac Index involves comparing the burger's price in a local currency, converted to a common base currency (usually the U.S. dollar), against the actual price of a Big Mac in the base country²⁹, ³⁰.

If a Big Mac costs more in a foreign country when its price is converted to the base currency using the market exchange rate than it does in the base country, the foreign currency is considered overvalued. Conversely, if it costs less, the foreign currency is considered undervalued. For example, if a Big Mac costs $5.58 in the U.S. and the equivalent of $4.00 in Country X, this suggests Country X's currency is undervalued relative to the U.S. dollar, based purely on the burger's price²⁸. This simple comparison offers a quick gauge of whether goods and services have a similar cost of living across borders after accounting for exchange rates.

Hypothetical Example

Consider a hypothetical scenario comparing the price of a Big Mac in the United States and Japan.

• Price of a Big Mac in the United States = $5.69
• Price of a Big Mac in Japan = ¥410
• Actual market exchange rate = ¥155 per $1

Step 1: Calculate the implied PPP exchange rate.
$\text{Implied PPP Exchange Rate (JPY per USD)} = \frac{\text{Price of Big Mac in Japan}}{\text{Price of Big Mac in U.S.}} = \frac{¥410}{\$5.69} \approx ¥72.06 \text{ per } \$1$

Step 2: Compare the implied rate to the actual market exchange rate.
The implied rate is ¥72.06 per $1, but the actual market exchange rate is ¥155 per $1.

Step 3: Determine over or undervaluation of the Japanese Yen against the U.S. Dollar.
$\text{Undervaluation of JPY} = \left( \frac{\text{Implied PPP Rate}}{\text{Actual Exchange Rate}} - 1 \right) \times 100\%$
$\text{Undervaluation of JPY} = \left( \frac{72.06}{155} - 1 \right) \times 100\% \approx (0.465 - 1) \times 100\% = -53.5\%$

In this hypothetical example, the Japanese Yen would be considered undervalued by approximately 53.5% against the U.S. dollar, according to the Big Mac Index. This suggests that the cost of goods and services is comparatively cheaper in Japan, or that the market foreign exchange market is not fully reflecting Purchasing Power Parity.

Practical Applications

While originally a "lighthearted" guide, the Big Mac Index has found several practical applications in the realm of International Economics. It serves as an accessible starting point for understanding currency valuation and can offer insights into global economic imbalances.

For²⁷ instance, economists and analysts sometimes use it as a quick sanity check to see if market exchange rates deviate significantly from what the theory of Purchasing Power Parity would suggest. Institutions such as the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) also employ more comprehensive PPP calculations for their economic analyses and policy recommendations, reflecting the broader importance of cross-country price comparisons. The ²⁵, ²⁶Federal Reserve Bank of St. Louis, for example, has published analyses comparing the Big Mac Index to overall Consumer Price Index inflation, noting its ability to track prices for food away from home.

Mor²³, ²⁴eover, the index is often cited in discussions about the true economic size of countries, especially when comparing Gross Domestic Product based on market exchange rates versus PPP-adjusted rates, which can significantly alter a country's perceived economic standing. The ²²World Bank, through its International Comparison Program, also utilizes extensive PPP data to compare the real value of money across countries to understand global development and poverty.

²⁰, ²¹Limitations and Criticisms

Despite its widespread popularity and illustrative simplicity, the Big Mac Index faces several notable limitations and criticisms as a precise measure of currency valuation.

One¹⁸, ¹⁹ primary criticism is that the Big Mac, while standardized to a degree, is not a perfectly identical product across all countries. Vari¹⁶, ¹⁷ations can exist in ingredients, portion sizes, and preparation methods due to local tastes, regulatory requirements, or supply chain differences. Furthermore, the Market Price of a Big Mac is influenced by numerous local factors beyond just the exchange rate. These include local labor costs, real estate costs for the restaurant, taxes (such as sales tax or VAT), import duties on specific ingredients, and differences in Monetary Policy. The ¹⁵profitability strategy of McDonald's in different markets can also vary, influencing pricing. For ¹⁴example, in some countries, McDonald's may be considered a premium dining option rather than an inexpensive fast-food choice, affecting demand and pricing.

The¹³ Big Mac Index also doesn't account for trade barriers or the fact that Big Macs are generally non-tradable goods – they are produced and consumed locally, rather than being imported and exported between countries. This m¹²eans that the forces of international arbitrage, which would ideally equalize prices for tradable goods, do not apply directly to a Big Mac.

Academically, while often used as an example, more rigorous measures of Purchasing Power Parity (PPP) typically involve a broad "basket of goods and services" comprising thousands of items to provide a more comprehensive and accurate comparison of price levels and economic productivity across nations. Relying on a single item can oversimplify complex economic realities and may not fully capture all factors influencing a currency's value. For in¹⁰, ¹¹stance, a study from the Federal Reserve Bank of San Francisco notes that while Big Mac real exchange rates are often correlated with aggregate real exchange rates, they also have unique dynamics.

Bi⁹g Mac Index vs. Purchasing Power Parity

The Big Mac Index is a simplified, informal application of the economic theory of Purchasing Power Parity (PPP). While both aim to compare the purchasing power of different currencies, their methodologies and rigor differ significantly.

Purchasing Power Parity (PPP) is a macroeconomic concept that states that in the long run, exchange rates between two currencies should adjust to equalize the prices of an identical basket of goods and services in both countries. It is a foundational theory used by economists and international organizations like the World Bank and OECD to compare economic productivity, real Gross Domestic Product, and Cost of Living across nations by eliminating differences in price levels. Profes⁶, ⁷, ⁸sional PPP calculations involve extensive surveys of thousands of comparable goods and services.

In contrast, the Big Mac Index uses only a single, globally recognized product – McDonald's Big Mac burger – as its "basket of goods". It was explicitly designed by The Economist as a humorous and easily understandable way to illustrate the underlying principles of PPP. While it o⁵ffers a quick glance into potential currency valuation discrepancies, it lacks the comprehensive data and methodological sophistication of formal PPP calculations. Consequently, the Big Mac Index is a simplified proxy, useful for general illustration rather than precise economic analysis or forecasting.

FAQs

⁴### What does it mean if a currency is undervalued according to the Big Mac Index?

If a currency is undervalued by the Big Mac Index, it means that the Big Mac costs less in that country, after converting its local price to U.S. dollars at the prevailing exchange rate, than it does in the United States. This suggests that the purchasing power of the local currency is stronger than what the market exchange rate indicates, meaning goods are comparatively cheaper in that country.

How f³requently is the Big Mac Index updated?

The Economist typically updates and publishes the Big Mac Index twice a year. This regul²ar publication allows for ongoing, informal comparisons of Purchasing Power Parity and currency valuation trends across various global economies.

Can the Big Mac Index predict future exchange rates?

While the Big Mac Index offers insights into current currency valuations based on a simplified Purchasing Power Parity model, it is not intended as a precise tool for predicting future exchange rate movements. Its limita¹tions, such as neglecting local Cost of Living factors beyond the burger and the non-tradable nature of the Big Mac, mean that actual market exchange rates are influenced by a far broader range of complex economic factors.