What is the Big Mac Index? How a sandwich is used to compare countries’ economies

The Big Mac Index has been a resource used to evaluate the purchasing power of different countries since its creation in 1986 by British magazine The Economist. It’s a light-hearted analysis of the economy based on the price of the iconic burger of McDonald’s.

What is the Big Mac index?

Let’s understand how the Big Mac Index works. At its core, this index compares the price of the Big Mac in various countries in terms of U.S. dollars.

To compute for the Big Mac PPP exchange rate between two countries, the price of the sandwich is calculated in the country’s currency, then divided by its price in another country. The number you come up with will be the exchange rate.

You then compare this number with the actual exchange rate. If the number you get is higher than the exchange rate, then the first currency is overvalued. If the value is lower than the exchange rate, then the first currency is undervalued compared to the second.

This idea is based on the theory of Purchasing Power Parity (PPP), which states that in the long term, exchange rates should equal the prices of an identical basket of goods and services in different countries. The basket, in this case, being the Big Mac.

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Advantages and disadvantages of the Big Mac Index

Using the Big Mac Index has some advantages. It’s simple and easy to understand, which makes it accessible to the general public. It provides a quick comparison of currency values using a common product. The Big Mac is also a standardized product and widely available throughout the world.

However, this simplicity comes with several limitations. The Big Mac is just one product, and its price is influenced by a number of factors such as local production costs, taxes and the profit margins of the franchise. Local economic conditions, taxation, and supply chain costs can also affect Big Mac prices independently of currency values.

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This means that it cannot be considered a complete representation of an identical basket of goods and services. Additionally, this index does not take into account differences in quality of life, inflation rates, supply and demand, or broader economic and business factors that can affect rates of change.

It would not be prudent to rely upon the index as a measure for economic analysis or investment decisions.

The Big Mac Index may not be entirely accurate as a standalone standard, but it provides a useful, accessible, and engaging way to discuss economic concepts and compare purchasing power across countries.