Overview
This lecture explains the Big Mac Index, a tool used to compare currency values by examining the price of Big Macs in different countries and discusses its uses and limitations.
Purchasing Power Parity & Exchange Rates
- Economists expect exchange rates to adjust so that a basket of goods costs the same in every country.
- The problem: the "average basket" differs between countries, making direct price comparisons difficult.
The Big Mac Index
- The Big Mac Index was introduced by The Economist in 1986 for consistent international price comparison.
- The Big Mac is used because its ingredients and preparation are largely standardized worldwide.
- Comparing Big Mac prices across countries helps reveal if currencies are undervalued or overvalued.
Limitations of the Big Mac Index
- Ingredient costs such as sesame seeds vary and additional expenses like transport and taxes affect prices.
- Labor and rent costs differ by country, influencing Big Mac prices.
- Only McDonald’s can sell Big Macs, limiting competitiveness or true price alignment.
Uses of the Big Mac Index
- Economists use it to get a general sense of potential long-term movement in exchange rates.
- Consumers can estimate relative prices and purchasing power when traveling.
- Big Mac enthusiasts can use it as a quirky travel guide.
Key Terms & Definitions
- Exchange Rate — the value at which one currency can be exchanged for another.
- Purchasing Power Parity (PPP) — the economic theory that exchange rates should adjust so identical goods have the same price globally.
- Big Mac Index — an informal tool for comparing the purchasing power of different currencies using the price of a Big Mac.
Action Items / Next Steps
- Review the concept of purchasing power parity.
- Explore recent Big Mac Index data for specific country comparisons.