The Big Mac index is a survey created by The Economist magazine in 1986 to measure purchasing power parity (PPP) between nations, using the price of a McDonald's Big Mac as the benchmark.
Purchasing power parity is an economic theory which states that exchange rates over time should move in the direction of equality across national borders in the price charged for an identical basket of goods. In this case, the basket of goods is a Big Mac.
Big Mac Index
- The Big Mac Index was created to measure the disparities in consumer purchasing power between nations.
- The burger replaces the "basket of goods" traditionally used by economists to measure differences in consumer pricing.
- The index was created with tongue in cheek but many economists say it's roughly accurate.
The Big Mac Index is also known as the Big Mac PPP or Burgonomics.
Understanding the Big Mac Index
One of the key insights of the Big Mac Index is that a basket of goods in one country can rarely be precisely duplicated in another country. For example, an American basket of groceries and a Japanese basket of groceries are likely to contain very different products. A Big Mac, though, is always a Big Mac, allowing for slight local differences in ingredients.
The editors of The Economist editors stress that the index should not be taken too seriously. "Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible," an article on the site indicates.
Based on the Big Mac Index, the British pound was undervalued by 27% against the U.S. dollar in January 2019.
Nevertheless, the Big Mac Index has become a global standard for price comparison. The website statistica.com, for example, uses it to track local purchasing power internationally, revealing that a Big Mac is relatively pricey in Switzerland, while people in Azerbaijan, Egypt, and Moldova are getting a bargain.
Example of the Big Mac Index
In January 2019, The Economist concluded that the British pound was undervalued by 27% against the U.S. dollar, based on the Big Mac Index. That is, a Big Mac then cost $5.58 in the U.S. and 3.19 pounds in the U.K. That difference suggests an implied exchange rate of 0.57%, but the actual exchange rate at that time was 0.78%.
As The Economist editors are quick to note, the Big Mac Index is not a perfect instrument.
To cite one, as of mid-2019, McDonald's has outlets in only 119 countries out of a total of 195. Thus, we cannot use this methodology to analyze the PPP between the U.S. dollar and the Bolivian boliviano or the Icelandic krona, among others.
Nevertheless, economists consider the index to be a fairly accurate real-world indicator of local economic purchasing power, since the pricing of a Big Mac, like most consumer goods, must take into account local costs of raw materials, labor, taxes, and business premises.