Many economists believe that exchange rates should eventually adjust to make the price of goods the same in different countries. However, a basket of goods bought in say, the USA is in reality quite different to the same basket of goods bought in, for example, China.
So, the Big Mac Index was devised by Pam Woodall from The Economist in 1986 as a light-hearted guide to study if currencies are at the correct level. By replacing the shopping basket with a Big Mac hamburger, the Index was devised as an informal illustration of PPP (Purchasing Power Parity), the notion that $1 should buy the same amount of goods in all countries. As a Big Mac contains virtually the same ingredients in different countries across the world (it is produced in over 100 countries), it can be used to show if any currencies are over or under valued.
The Big Mac PPP exchange rate between two countries is obtained by dividing the price of a Big Mac in one country (in its currency) by the price of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.
For example, if the price of a Big Mac is $4 in the USA as compared to £2.50 in the UK, we would expect the exchange rate would be 1.60 (4 divided by 2.50 = 1.60). If the exchange rate of dollars to pounds is any greater the Big Mac Index would state that the pound was overvalued; any lower and it would be undervalued.
The Economist has published data for the Big Mac Index annually since it was first outlined in 1986.
However, the idea does have flaws. For instance, the Big Mac differs across the world in size, some ingredients and availability. Some ingredients like sesame seeds might be cheaper in one country, although the price of transporting them to other locations may eliminate any profit, and there might also be import taxes to consider. Also, it is not just the price of ingredients that matter. Prices for things like labour and ground rents may vary greatly from country to country. Geography also has an influence – for example, the demand for Big Macs is not as large in countries such as India as in the United States. Also, in Africa McDonald’s is only present in Morocco, Egypt and South Africa.
Incidentally, there has been an alternative index created solely for Africa called the KFC Index to compile data. In 2007, an Australian bank tried a variation the Big Mac index, called the “iPod index”, working on the idea that since the iPod was manufactured at a single place, the value of iPods should be more consistent globally (however, this theory ignored shipping costs, which varied depending on how far the product was delivered from its “single place” of manufacture in China). In the same year, the comparison platform Versus came up with a version called The Starbuck’s Chai Latte Global Index, to compare prices worldwide.
Perhaps more usefully, a Swiss bank expanded the idea of the Big Mac index to include the amount of time that an average local worker in a given country must work to earn enough to buy a Big Mac.
I recently stumbled across this connected indicator on the excellent ‘Statistica’ web site ( https://www.statista.com) which looks at the comparative costs of a night out in selected cities across the world. It seems that Saturday night escapades are the cheapest in Mexico City whilst your pocket is hit hardest in Zurich, Miami or Stockholm. I wonder who got the fun job of researching this data?
In 2018, McDonalds celebrated the 50th anniversary of the Big Mac by issuing its own currency – the Mac Coin. Each Mac Coin was to be redeemable for one free Big Mac the world over (well, over 50 countries anyway) , but only up to the end of 2018.
So, what is the Big Mac Index useful for? Economists can use it to consider how exchange rates will move in the long term, while consumers can use it to compare prices in different countries, and work out how far their money will go when they are travelling. Geography teachers can use it to compare living costs in different countries, and observe changes over time as countries develop at different speeds.