Big Mac Index

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MINISTRY OF EDUCATION REPUBLIC OF MOLDOVA
INTERNATIONAL LIBERAL UNIVERSITY OF MOLDOVA

FACULTY OF ECONOMICAL SCIENCE

Big Mac Currencies (The 2002 Big Mac Index)
Foundation of Economics
Economics Efficiency

International Investments
Presentation Paper
October 19, 2012

Chisinau 2012
Foundation of Economics

THE BIG MAC index

The Big Mac is the world’s most popular sandwich, was created in 1968 by a McDonald’s franchise in Pittsburgh, Pennsylvania. While most people see the Big Mac as a sandwich, economists also see that as a consumer good which is sold at over 25,000 McDonald’s restaurants in 120 countries around the world. Because of its popularity, the Big Mac allows economists to make (admittedly unscientific) comparisons of exchange rates and relative prices in countries around the globe. This Economics Minute looks at how the "Big Mac Index" helps explain variation in exchange rates and prices. In 1972, just before the collapse of the Bretton–Woods system of fixed exchange rates, the US dollar cost about 40 British pence. By 1985, the dollar had appreciated to 90 pence, but by the end of December 2008, it had fallen back to 67 pence. As such substantial changes in currency values over the longer term are commonplace in a world of floating exchange rates, the understanding of the valuation of currencies is a significant intellectual challenge and of great importance for economic policy, the smooth functioning of financial markets, and the financial management of many international companies. While exchange-rate economics is a controversial area, a substantial body of research now finds that over the longer term exchange rates are ‘anchored’ by price levels. This idea is embodied in purchasing power parity (PPP) theory, which states that the exchange rate is proportional to the ratio of price levels in the two countries. A new and simple way of making PPP comparisons was introduced in 1986 by The Economist magazine. This involves using the price of a Big Mac hamburger at home and abroad as the price ratio that reflects the underlying value of the currency. This price ratio is known Burgernomics An economics term made popular by the Big Mac Index published by The Economist. Burgernomics makes reference to the idea of the Big Mac PPP, which examines the purchasing power parity between nations, using the cost of a Big Mac as the benchmark. 

Burgernomics
An economics term made popular by the Big Mac Index published by The Economist. Burgernomics makes reference to the idea of the Big Mac PPP, which examines the purchasing power parity between nations, using the cost of a Big Mac as the benchmark. 

as the ‘Big Mac Index’ (BMI), which forms the basis for ‘Burgernomics’. When compared to the actual exchange rate, the BMI purports to give an indication of the extent to which a currency is over- or under-valued according to the law of one price. ‘Seeking to make exchange-rate theory more digestible’ (The Economist, 9th April 1998), the Index has been published for 24 years for an increasing number of currencies (now more than 30) and is claimed to be a successful new product from a number of perspectives. In the words of The Economist, Big Mac index was first launched in 1986 as a gastronome's guide to whether currencies were at their correct exchange rate. It is not intended to be a precise predictor of currency movements, but simply a way to make exchange-rate theory a bit more digestible. Purchasing Power Parity - PPP

An economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power.

The relative version of PPP is calculated as:

Where: 
"S" represents exchange rate of currency 1 to currency 2  "P1" represents the cost of good "x" in currency 1
"P2" represents the cost of good "x" in currency 2

Purchasing...
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