My goal for this blog, as the tagline says is to make “economic principles understandable to regular people.” And what’s more understandable than a Big Mac? Unless you’re a vegetarian…in which case, um…sorry.
In any case, in Economists’ long quest to make economic principles relevant, they’ve come up with something called the Big Mac Index, to measure what’s known as purchasing power parity. I dare you to say that ten times fast.
Basically, that’s a complicated sounding term that just means that you should be able to buy an identical good in two countries for the same price when the price is expressed in the same currency.
In Big Mac terms, if you were to travel to another country, you should be able to purchase a Big Mac for roughly the equivalent of whatever a Big Mac costs in the US.
So why does this even matter?
|Big Mac Index|
Well, the theory behind the index is that if you can’t purchase a Big Mac in another country for roughly the equivalent of the price that you can purchase it for in the US, the foreign currency is either overvalued or undervalued.
The implications of an overvalued or undervalued currency are a post for another time, but here’s a quick explanation. When a currency is overvalued, you’re paying too much for a Big Mac (or any good you buy!). If a currency is undervalued, you’re paying too little for a Big Mac.
The advantage to overvaluing a currency is that people who have that overvalued currency can buy goods from other countries very cheaply.
So, for example, we see that according to the Big Mac Index, Switzerland’s currency, the Franc, is overvalued. A Big Mac costs the equivalent of $6.81. If someone exchanged their Swiss Franc’s for United States Dollars, they could buy the equivalent of about 1.5 Big Macs. If they wanted to get an even better deal, they would exchange their Franc’s for an undervalued currency like India’s Rupee, and purchase just over 4 Big Macs. Sounds like a pretty good deal, eh? We’ll talk about the downsides of an overvalued currency later.
On the other hand, in a country with an undervalued currency, goods can be sold to other countries very cheaply. According to the Big Mac Index, India and China have undervalued currencies...those also happen to be two countries that the USA buys a lot of cheap goods from.
Anyway, back to the original point. The Big Mac Index may sound a little silly, but it’s a useful tool for gauging your purchasing power in other countries.