Could a Big Mac Meal Measure the Value of Currencies?
Have you ever thought it possible for the value of your country's currency to be measured in relation to a burger sandwich? Or for it to indicate your nation's Net National Income (NNI)? To aptly answer this, we better take a closer look at the so-called Big Mac Index, the most comical indicator in the realm of financial markets.
What is the Big Mac Index?
In 1986, The Economist newspaper came up with a fun way to detect whether currencies are trading at their correct levels in what they called the Big Mac Index. This index is built to work on a basis similar to that of the Purchasing Power Parity (PPP). But instead of using prices of a "basket of goods" as the metric for comparing different currencies, the Big Mac Index uses the price of McDonald's Big Mac meal. The Economist even tweeted recently, "The Big Mac Index has become a global standard, included in several economic textbooks and the subject of dozens of academic studies."
How does the Big Mac Work?
The Big Mac Index operates under the rules of Burgernomics, which was developed for people to better grasp the concepts and theories of exchange rate determination, but how does it work?
As mentioned earlier, the Big Mac Index works similarly to the PPP, comparing the price of the Big Mac across McDonald's branches in different countries around the world. The Index showcases that the cost of the same meal is reasonable in certain countries like Egypt, while it is not so reasonable in places like Switzerland. The standardized measurable for the index is the price of Big Mac in the American Dollar. For example, if you had wanted to buy a Big Mac meal in the United States in January 2018, you would have paid around USD 5.28, while in Egypt, it would have been USD 1.93 and USD 6.67 in Switzerland. Thus, demonstrating the varying purchasing power one currency could have in different geographical locations. The previous example illustrates how the Big Mac Index explains the exchange rate determination by showing that with USD 1, you can afford different types and quantities of goods in the States than in Egypt and Switzerland. Thereupon we conclude that the Dollar is worth more in Egypt than in the United States and even more compared to Switzerland.
We can also estimate whether the exchange rate for a given currency is overvalued or undervalued by measuring each currency against a unified standard with the Big Mac Index. The Economist releases the index twice a year by appropriating the average national price to the prices of the Big Mac in the United States of the same period.
But why the Big Mac? Big Mac meals come in one size, are prepared with the same ingredients, and are the best-selling food item within the world's biggest food chain, McDonald's, almost in every country in the world. Not to mention, the Big Mac index exceeded expectations in its global reach, becoming a simplified indicator for currencies purchasing power.
What is the Link Between the Big Mac Index and Gross Domestic Product (GDP)?
*Source: The Economist.
The Big Mac Index draws a relationship between a country's GDP per capita and how much its residents get to pay for a Big Mac meal. It states that the higher a country's GDP per capita is, the more pricy it is to buy a Big Mac. So, the more expensive Big Mac is in one place, the more prosperous and economically advanced it tends to be. This explains why a Big Mac meal costs USD 7 in Switzerland – as of July 2021 - while the same sandwich costs USD 5.65 in the United States and USD 5.02 in the Eurozone.
How Accurate is the Big Mac Index?
Like any other indicator, the Big Mac Index is not an accurate measure of the country's economic growth or inflation rate without considering other factors, including differing meat consumption rates, tax rates, and the income gap between different countries. However, the Big Mac Index is one of the most developed yet lighthearted tools that can give you a tangible indication of how strong or weak a country's economy is.