Big Mac index

The Mc Donald Big Mac index, also known as the Big Mac Purchasing Power Parity (PPP) is a periodic survey done by “The Economist” magazine. This index measures the Purchasing Power Parity between nations using the international prices of the burger as a benchmark (R.L.W., 2014). The index draws its rationality from the concept of “the law if one price”, which infers that in the long-run, all goods must sell for the same price in all locations. This law constitutes the bases of the Purchasing Power Parity theory, which is derived from no arbitrage postulation.

The law of one price indicates that identical goods ought to be sold everywhere for the same price. If this assumption did not hold any merit, anyone would have been able to use the international markets to purchase good where it’s cheaper, thus increasing its price there due to demand and supply; then they can sell those items in their local economy and in doing so, simultaneously depressing the price here. This process called “Arbitrage ” leads overtime to the same good being sold overtime everywhere for the same price.

The law of one price is ease to test in the same country, this is done through comparing the prices of goods; example, is the price of a meal the same in different cities within the same country (Port of Spain, Chaguanas, San Fernando) or within Trinidad’s sister island Tobago? The theory indicates that prices ought to be homogenous throughout. Conversely, the comparison of prices between different countries where different currencies are used tends to be a lot more difficult; however, this can still be done by looking at international currency markets where traders exchange currencies at some rate of exchange depending on the demand and supply of each c...

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... the ingredients that matter, price of labor and rent is different between both countries, and even if you can import all the goods, unless you’re fortunate to have a Mac Donald’s franchise, unlike Trinidad and Tobago’s neighboring Caribbean islands, you are unable to make a comparison in the real and nominal foreign exchange rates using this index.

After examining the flaws of the index and understanding that it was never intended to be a measure of currency misalignment; the question can be asked “so what can you use the Big Mac index for?” Will, it’s simple to conclude by inferring that if you’re an economies, the index still gives some indication of how the exchange rate is expected to move over a period of time (specifically, the long-run), and if you’re a consumer, it gives you an idea of prices of other countries, and how far you can expect your money to go.