What Is the Big Mac PPP?
The Big Mac PPP (purchasing power parity) is an annual survey started in 1986 by The Economist that examines the relative over or undervaluation of currencies based on the relative price of a Big Mac across various countries of the world. Although it is appears to be in jest, the Big Mac PPP is a fairly good starting point when measuring the purchasing power between currencies.
- The Big Mac PPP is an informal index used to compare the purchasing power between currencies as compared to the price of a McDonald's Big Mac.
- Another name for the Big Mac PPP is the Big Mac Index.
- Currencies are compared against the local price of a Big Mac in that nation's currency. Depending on the ratio, the currency could be considered over or undervalued.
Understanding the Big Mac PPP
Purchasing power parity (PPP) is the theory that currencies will go up or down in value to keep their purchasing power consistent across countries. The premise of the Big Mac PPP survey is the idea that a Big Mac is the same across the globe.
Big Mac PPP is also known as the Big Mac Index. The Big Mac Index measures purchasing power parity (PPP).
It has the same inputs and distribution system, so it should have the same relative cost from country to country. With Big Mac PPP, purchasing power is reflected by the price of a McDonald's Big Mac in a particular country. The measure gives an impression of how overvalued or undervalued a currency is.
How to Calculate the Big Mac PPP
Big Mac PPP is calculated by examining the price of a Big Mac in a given country in its home currency and divides it by the price of a Big Mac in the second country, which is usually the United States. Let's say that we are looking at the Big Mac in China. If a Chinese Big Mac is 10.41 renminbi (RMB) and the U.S. price is $2.90, then—according to PPP—the exchange rate should be 3.59 RMB for US$1. However, if the RMB were actually trading in the currency market at 8.27 RMB for US$1, the Big Mac PPP would suggest that the RMB is undervalued.
Something the Big Mac Index fails to take into consideration is that while the inputs of the Big Mac and the way the Big Mac is manufactured and distributed is uniform across all countries, the costs associated with the labor to staff the stores, the cost of the storefront, additional costs within the franchise license to operate the McDonald's restaurant and costs to import/acquire the inputs might be different across countries. This may sway the price of the Big Mac and throw off the ratio relative to the cost of the U.S. version.
Despite this, the Big Mac Index is still a good starting point in determining currency discrepancies. The Index is an example of how PPP is used, and should not be considered the definitive comparison tool.