What Is the Starbucks Index?
The Starbucks Index is a heuristic measure of purchasing power parity (PPP) comparing the cost of a tall latte in local currency against the U.S. dollar in 16 countries. The Starbucks Index was created by The Economist based on its original Big Mac index which was described as “a lighthearted guide to whether currencies are at their “correct” level." Using this index, the purchasing power of each national currency can be reflected in the U.S.-dollar cost of a latte in that country. A latte costing significantly less in one country suggests an undervalued currency. The Wall Street Journal regularly publishes a similar "Latte Index."
- The Starbucks Index is a measure of purchasing power parity (PPP) that compares the relative prices of a tall latte coffee in 16 different countries.
- PPP states that because of the market for currency exchange rates, the prices of like goods in one country should be the equivalent when valued in another country's currency.
- The Big Mac Index is another popular measure of PPP using hamburgers instead of coffees.
Understanding the Starbucks Index
The Starbucks Index measurement of PPP is a theory that goods in one country will cost the same in another country, once the exchange rate is applied. According to this theory, two currencies are at par when a market basket of goods is valued the same in both countries. PPP rates are determined by comparing the prices of identical items in different countries. This comparison is often difficult, however, due to differences in product quality, consumer attitudes and economic conditions in each country.
Relative purchase power parity considers the difference between two countries’ rates of inflation in driving changes in the exchange rate between the two countries over time. RPPP expands on the idea of purchase power parity, and complements the theory of absolute purchase power parity.
Purchasing Power Parity (PPP)
Purchasing power parity (PPP) is one popular macroeconomic analysis metric used to compare economic productivity and standards of living between countries. PPP is an economic theory that compares different countries' currencies through a "basket of goods" approach.
According to this concept, two currencies are in equilibrium—known as the currencies being at par—when a basket of goods is priced the same in both countries, taking into account the exchange rates between the two currencies.
While it's not a perfect measurement metric, purchase power parity does let one compare pricing between countries with differing currencies.
The Big Mac Index
The Starbucks Index is closely related to the Big Mac Index. The Big Mac index, also known as Big Mac PPP, is another survey done by The Economist magazine that is used to measure the purchasing power parity (PPP) between nations, using the price of a McDonald's Big Mac as the benchmark.
Taking the idea of PPP from economics, any changes in exchange rates between nations would be seen in the change in price of a basket of goods, which remains constant across borders. The Big Mac index suggests that, in theory, changes in exchange rates between currencies should affect the price that consumers pay for a Big Mac in a particular nation, replacing the "basket" with the popular hamburger.
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.