The Big Mac Index is an informal measure of the purchasing power parity (PPP) between two currencies. As it’s name suggests, the Big Mac Index uses the world famous McDonald’s Big Mac to measure PPP. It was developed, and is published annually by, by The Economist to determine whether market exchange rates result in goods costing the same in different countries.
In theory, when predicting exchange rate movements, economists predict that the rate between two currencies will naturally adjust so that a sample basket of goods and services costs the same in both currencies. The idea behind the Big Mac Index is that the Big Mac is available in a common specification in McDonald’s franchises across many countries around the world. Seemingly, the price of a Big Mac should equalise between all the countries because its the same burger.
How it Works
The Big Mac PPP exchange rate between 2 countries is calculated by dividing the price of a Big Mac in one country (in its currency) by the price of a Big Mac in another country (in its currency). The idea is then to compare this index with the actual exchange rate between the 2 countries. If it is lower, then the first currency is under-valued compared to the second. Conversely, if it is higher, then the first currency is over-valued compared to the second.
However, this burger methodology faces some criticisms. For instance, in many countries, it is relatively dear to eat at a fast-food franchise restaurant like McDonald’s compared to local restaurants. Moreover, the price of a Big Mac in different countries may not depend solely on input costs but also on the social status of eating at fast food restaurants as well as different tax rates and import duties on the burger’s inputs. Also, the Big Mac is not sold in all countries, so it cannot be used as a world-wide comparison. Similarly, in some countries, such as India, the Big Mac is not a beef burger but a chicken burger. Furthermore, McDonald’s uses different commercial strategies in different countries, resulting in huge price differences for the Big Mac. Thus, the price of a Big Mac reflects the costs of its local production, delivery costs, advertising costs and local labour costs. Since all these factors are likely to vary from country to country, the comparison of the price of a Big Mac in different countries is not an accurate reflection of their relative currency values.