A Big Mac Is More Than Tasty, It's A Brilliant Economist


Tasty and cram-packed with cement cholesterol for your arteries, McDonalds' Big Mac has been nation wide since 1968 the binge food of choice for drunks and tokers alike. 

And why shouldn't it be? The Big Mac consists of two 1.6 oz (45.4 g) 100 per cent beef patties, American cheese, "special sauce" (a variant of Thousand Island dressing),iceberg lettuce, pickles, and onions, served in a three-part sesame seed bun.
Aside from these measurements, the Big Mac also serves as a cutting edge analytical indicator for economist, social scientists, and general social sentiment. That point should be obvious considering that McDonalds has restaurants in 116 countries around the world. 

 Big MacCurrencies or Big Mac Price Index

Fist to mention is that McDonalds’ Big Macs are not traded between countries, but are sold to individuals and marketed as tasty, consumer convenience. McDonalds has certainly kept with KISS (Keep It Simple, Stupid) along the way.

As mentioned, there are McDonalds restaurants operating in over 116 countries around the world. This gives economists a strategic web of information about local Big Mac prices, which then can be compared with a given foreign exchange rate or rates that provide indications to changes in currency exchange rates. For example, the The Economist covers some of these concepts in “Big MacCurrencies” (The Economist). 

Here is how the methodology is used, which is similar to what I have explained: 
“Burgernomics is based on the theory of purchasing-power parity, the notion that a dollar should buy the same amount in all countries. Thus in the long run, the exchange rate between two currencies should move towards the rate that equalises the prices of an identical basket of goods and services in each country. Our “basket” is a McDonald's Big Mac, which is produced in about 120 countries. The Big Mac PPP is the exchange rate that would mean hamburgers cost the same in America as abroad. Comparing actual exchange rates with PPPs indicates whether a currency is under- or overvalued." 
Application 

So, for example, if country X prices its Big Mac at 14.50 to the cost of country Y’s currency exchange rate of 5.00, (5.00 /14.50 = 2.90) suggests that it would cost $2.90 to purchase a Big Mac in country X for country Y. This does not tell us much without the final part of the equation. 

Let’s assume that the local price of a Big Mac in country Y cost 2.50. However, when calculating the exchange rate, the price for a Big Mace in country X is actually .40 more. Economist would judge that country X’s currency might be over-valued against the currency of country Y

For the cost of the Big Mac in country X to equal the price of the Big Mac in country Ycountry X’s currency would need to appreciate from 14.50 to 12.50 against country Y’s currency. Using the same formula it looks like this: (5.00 / 12.50 = 2.50) which is equal to the price of the Big Mac in country Y.

Here is another example from The Economist to close, “the average price of a Big Mac in America in July 2013 was $4.56; in China it was only $2.61 at market exchange rates. 

So the "raw" Big Mac index says that the yuan was undervalued by 43% at that time” (The Economist, The Big Mac index). Big surprise there. Red China loves Big Macs and devaluing its Yuan against the Buck. 

References 

The Economist (2000). Big MacCurrencies. Retrieved from http://www.economist.com/node/305167

The Economist (2013). The big mac index. Retrieved from http://www.economist.com/content/big-mac-index

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