Big Mac Index

Big Mac Indexrefers to a currency comparison tool that checks the cost of a McDonald's Big Mac burger to measure the purchasing power parity (PPP) between countries. Also known as Burgernomics, the Economist introduced it in 1986 to offer a 'light-hearted' and interactive index to measure currency imbalance in respective countries.

The index uses the United States dollar as its base currency by default, and the price of a Big Mac in other countries is compared to the relative price of the burger in the US. This is because using a consumer good like food can be easier to understand than casually comparing currencies.

• The Economist Big Mac Index is a comparative tool that facilitates the comparison of the purchasing power parity between two countries using the price of a McDonald's Big Mac burger in the respective countries in their legal tender.
• The index became popular owing to using a simple consumer good for comparison. Many proponents of this index even argue that it is a more reliable tool for measuring inflation than CPI.
• Users can find the Big Mac Index calculator on the official Economist website and enter the inputs for the data required.

Big Mac Index or the Big Mac PPP is a widely studied measure to understand price differences, currency exchange rates, and inflation. This can be attributed to its simplicity and, to an extent, its versatility.

The simplicity here refers to using a burger – a food item commonly available and found worldwide. So, any comparison with a burger can be easy to comprehend. The versatility, on the other hand, is a striking feature.

Consider a burger. It consists of meat, buns, sauce, vegetables, and other ingredients. Now, consider what goes into making a burger—Labor, transportation, electricity and gas, and finally, a place to make it.

So when the price of a burger is considered, the economic value of all these factors is accounted for. Thus, comparing the prices of similar burgers in two countries reflects a region's cost of living and affordability. This is the theory behind Burgernomics.

Burgernomic's history dates back to September 1986, when Pam Woodall published it in the Economist to create a more digestible method to understand the PPP and compare currencies. Since then, the paper has published the index every year. 

The index follows the purchasing power parity theory, according to which the difference in exchange rates would equalize in the long run. The economist claims that the index was not intended to become a currency misalignment gauging tool. However, it has become pretty popular and widely studied. 

Now, let's look at how the index measures the PPP.

Step 1: Compare the price of Big Mac in two countries, A and B, by dividing its price in A's currency by B's. Here, B is the base currency. This will determine the exchange rate, E'. 

Step 2: E' is compared with the official exchange rate, E. 

Step 3: If E' is more significant than E, then currency A is overvalued; otherwise, it is undervalued.

Here's the formula to calculate the index:

Exchange rate, E' = Big Mac in currency A/ Big Mac in currency B

Comparing the official or actual exchange rate, E, between currencies A and B,

• If E' < E, currency A is undervalued
• If E' > E, currency B is overvalued

The Big Mac Index calculator is available on the Economist website, and the user has to enter the required inputs to get the desired data.

Consider the example of Big Mac prices in the US and Australia.

• The price of a US Big Mac is USD 5.81
• The price of an Australian Big Mac is AUD 7.15

Here, the USD is the base currency. So, let's compare AUD concerning USD.

Exchange rate, E’ = AUD 7.15/ USD 5.81 = 1.23

Actual exchange rate, E = 1.49

Since E' < E, thus it can be concluded that AUD is undervalued.

Let's look at the Burgernomics chart of July 2022 published by the Economist, which compares the British pound with the US dollar.

The chart is published every six months with the USD as the base currency. However, it is also possible to change the base currency. Currently, there are five options available – Euro, British pound, Japanese yen, Chinese yuan, and the US dollar. 

It is also possible to view the GDP-adjusted chart, which accounts for GDP per person. The chart displays how each currency is undervalued or overvalued. It also shows the trend from 2000 to the current year. 

The consumer price index is a tool that measures the inflation of products or services over time. It is a widely used measure of prices. However, criticisms have been against it, and its effectiveness is debatable. 

Many are comparing the Big Mac Index with CPI, as it is comprehensive and considers many factors. For example, a Big Mac's price includes its ingredients and other fixed costs like outlet rent, consumption costs, salaries, etc. So it can depict the actual situation and cost of living in a country. Therefore, an overall increase in each of these prices will be reflected in the Big Mac prices. 

There's enough skepticism that the CPI shows a lesser inflation value. However, compared to this, the Big Mac prices are considered somewhat reliable as a burger is a stable product that doesn't keep fluctuating. Also, it has worldwide consumption and can be better for comparative analysis. Further, many studies prove why Burgernomics might be better than CPI.

This article has been a guide to what is Big Mac Index. We explain its history with its formula, calculation, example, chart, a comparison with CPI. You may also find some useful articles here –

• ABS and MBS Index
• All Ordinaries Index
• Case Shiller Index