Background
The Big Mac Index is an informal measure of purchasing power parity (PPP) between two currencies. It was introduced by The Economist in 1986. The index uses the price of a McDonald’s Big Mac hamburger as a benchmark to compare and analyze the relative value of currencies.
Historical Context
Launched in 1986, the Big Mac Index aimed to simplify discussions around exchange rate theory by using a universally recognized product—the Big Mac. It has since become an iconic albeit lighthearted economic indicator, bridging the gap between complex economic theory and everyday consumers.
Definitions and Concepts
Big Mac Index: The ratio of the exchange rate that would equalize the price of the Big Mac sandwich between two countries to the actual exchange rate. If the resulting ratio is different from the actual forex rate, a currency might be considered under or overvalued.
Purchasing Power Parity (PPP): An economic theory stating that in the long term, exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services (in this case, a Big Mac) in any two countries.
Major Analytical Frameworks
Classical Economics
Classical economics focus on the idea of self-regulating markets. While the Big Mac Index doesn’t have direct classical roots, its basis on goods price comparison aligns loosely with classical ideas of market equilibrium.
Neoclassical Economics
Neoclassical economics, with its heavy reliance on mathematical models and equilibrium concepts, agrees with the Purchasing Power Parity theory, of which the Big Mac Index is a light-hearted, practical example.
Keynesian Economic
Keynesian economists might see the Big Mac Index as an oversimplification, preferring broader scopes of economic indicators like GDP or unemployment to test currency valuations.
Marxian Economics
Marxian economics might critique the Big Mac Index as trivializing or ignoring broader economic inequalities and labor dynamics between economies.
Institutional Economics
Institutional economists might appreciate the Big Mac Index as a real-world reflection of diverse institutional and cultural impacts on pricing.
Behavioral Economics
The Big Mac Index is indirect influence of behavioral economics appreciating its simplicity and direct relatability to everyday choices of consumers.
Post-Keynesian Economics
Post-Keynesian economists might view this index as an innovative yet limited tool for examining currency loops within the global economy.
Austrian Economics
Austrian economists, focused on subjective valuation, might argue that the Big Mac’s uniformity makes it a less useful measure since economic activities are diverse.
Development Economics
The Big Mac Index could be applied within development economics to probe into cost of living differences and economic disparities between developed and developing countries.
Monetarism
Monetarists might find appeal in the comparative simplicity of the Big Mac Index when discussing monetary neutrality and long-term price levels between nations.
Comparative Analysis
When comparing different currencies using the Big Mac Index, economists can quickly infer possible overvaluation or undervaluation. However, the Index should be interpreted with caution as it doesn’t account for all market frictions and economic policies affecting the currencies.
Case Studies
Various case studies have employed the Big Mac Index to illustrate purchasing power disparities. For instance, in the aftermath of economic crises, the Big Mac Index can reveal immediate currency market distortions.
Suggested Books for Further Studies
- “International Economics: Theory and Policy” by Paul Krugman and Maurice Obstfeld
- “Exchange Rates and International Finance” by Laurence S. Copeland
- “Globalization and Its Discontents” by Joseph Stiglitz
- “Purchasing Power Parity and Real Exchange Rates: Theory, Evidence, and Implications” by Mark Taylor and Alan Heston
Related Terms with Definitions
Exchange Rate: The value of one currency for the purpose of conversion to another.
Foreign Exchange Market (Forex): A global marketplace for exchanging national currencies against one another.
Purchasing Power: The financial ability to buy goods and services.
Inflation: The rate at which the general level of prices for goods and services rises, eroding purchasing power.
Basket of Goods: A fixed set of consumer products and services whose price is tracked for monitoring inflation within an economy.
