The famous Big Mac hamburger has also influenced the foreign exchange market! Come discover the importance of the Big Mac index as a tool for calculating purchasing power. Let us study an example of calculating the Big Mac index, its disadvantages, and alternatives that exist.Â
Big Mag index is based on the price of a burger ‘Big Mac’ sold in McDonald’s restaurants worldwide. It was invented by The Economist magazine in 1986 as a method of simple comparison of the PPP (purchasing power parity) between the currencies of various countries. To calculate the purchasing power parity between two countries, it is necessary to compare products “standards” that are found in each country. The Big Mac hamburger has proved ideal for this function, since one can find a McDonald’s in about 120 countries around the world, the Big Mac is therefore considered consumer goods available internationally, or “McCurrency.Â
The index measuring the purchasing power of Big Mac is pretty important. He predicts the evolution of the exchange rate between two currencies based on the price of a single Big Mac hamburger in these countries. The local McDonald’s franchises have a great responsibility on their shoulders: regulate the price of their Big Mac hamburger in order to maintain an overall constant PPP. The index measuring the purchasing power of a Big Mac there is also gaining accuracy.Â
The Big Mac index is determined by dividing the price of a Big Mac in one country (expressed in its own currency) by the price of a Big Mac in a second country (also expressed in its own currency). The result is compared to the real exchange rate. If the result is smaller, we say that the first country’s currency is undervalued. If, conversely, the result is larger, the first country’s currency is said to be overstated relative to that of other countries.Â
Here is an example of these explanations, drawn from the Big Mac index in 2008:Â
The respective prices of a Big Mac in England and the United States are Â£ 2.29 and $ 3.57. The index measuring the purchasing power of Big Mac is: $ 3.57 / Â£ 2.29 = 1.56. The real exchange rate at that time was $ 2.00 to Â£ 1.00. The result indicates that the book was so overvalued by 28% against the dollar.Â
The disadvantages of the Big Mac indexÂ
The accuracy of the Big Mac index can be altered by factors such as cultural differences, local taxes, levels of competition and import duties, specific to each country. Demand for Big Mac hamburgers also varies from one country to another. The Big Mac Index is acknowledged by economists as a valuable tool for calculating the parity of purchasing power in the world.Â
Variants of the Big Mac indexÂ
The simple idea hidden behind the index measuring the fill buying Big Mac has been adapted and developed by several organizations since its inception in 1986.Â
An alternative, developed by the investment bank UBS AG has extended the basic idea, including an additional figure: the number of hours an average employee has to work to afford a Big Mac hamburger. This model is called the Big Mac index is based on working time. Taking into account the local wage factor, it offers a more realistic view of purchasing power.Â
We hope that our article has given you a better understanding of the Big Mac index and it can help you in the future when you may need to do financial analysis. Check with other items on our site, to further improve your knowledge on the subject.
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