Big Mac Index

economic-dictionary

The Big Mac index is produced by the magazine The Economist, also known as the Big Mac purchasing power parity index, and its reference is the price of this famous hamburger in each country to determine whether or not its currency is overvalued in relation to another country with which I want to compare.

Based on the theory of purchasing power, the Big Mac Index uses the price of a Big Mac, which is a uniform product throughout the world. Otherwise it would not be a reliable indicator. The Big Mac index It is a uniform measure since hamburgers are manufactured exactly the same in all countries and establishments with a fairly homogeneous physical and personnel structure.

When comparing the price of a Big Mac in local currency, if the price of the Big Mac converted to dollars is less than the price of the Big Mac in the United States, our currency is undervalued against the dollar (below you can see an example).

Apart from other indicators that more accurately reflect purchasing power parity, it can be suitable as a measure to check whether or not a currency is overvalued, forgetting about short-term factors that may affect the behavior of currencies (such as an election or an attack).

We assume that the market is efficient, and the relationship between currencies should be similar to the relationship between the prices of goods in that country. In the example of the hamburger, this theory can be applied and considered that the market is efficient, because otherwise it would be possible to arbitrate and buy hamburgers in one country and sell them in another obtaining a risk-free margin.

Purchasing Power Parity (PPP)

Big Mac index example

If we take the 2016 Big Mac index as a reference, in which the cost of the Big Mac in the United States is $ 4.93 and its cost in the eurozone is € 3.72. Converting the Big Mac in euros to dollars at the official exchange rate of the moment (1 euro = 1,075 dollars) it turns out that a Big Mac in Europe is worth 4 dollars. I mean, the Big Mac is cheaper in Europe.

As the dollar price of the Big Mac in Europe is lower than the price of the Big Mac in the United States, we say that the euro is undervalued against the dollar (or the dollar is overvalued against the euro). In other words, the European currency should appreciate 18.9% (or the dollar depreciate 23.3%) to adjust to the real exchange rate, measured by the purchasing power of a Big Mac. Or what is the same, the The exchange rate should be 1 euro = 1.2325 dollars (which is equal to 1 dollar = 0.8113 euros). If in the conversion of the local currency to dollars its price is below this level, then the currency is undervalued. As the result indicates, as of January 2016 only Switzerland, Sweden and Norway have a "more expensive" Big Mac than in the United States. Most currencies are undervalued against the dollar and the Big Mac is "cheaper" (in US dollars) in the rest of the countries on the list.

Tags:  opinion present cryptocurrencies 

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