The Big Mac Index Explained
Twice a year The Economist publishes the Big Mac index. It is a fun guide to the world's currencies that attempts to adjust them all to an equitable level through the great equalizer known as the Big Mac. Being one of the few prepared food items that can be purchased nearly across the globe, it serves as a great bellweather: Is a country's currency over-valued?
Even the Economist admits to this being a light-hearted and not entirely serious "index", but it's certainly caught on, having been the subject of numerous academic studies. At Travelex, we just like that it simplifies the scary and confusing world of global currencies, and hope that it might just inspire you to take that next step in visiting a far away place. To show our love for the Economist's Big Mac index, we've created this video, "The Big Mac Index Explained". Take a look:
Many economists believe exchange rates should eventually adjust to make the price of a basket of goods the same in each country. But the average basket of goods in America is different from the average basket in China. To overcome this problem the Economist introduced the Big Mac Index in 1986, because apart from a few exceptions, the Big Mac has the same ingredients worldwide. Comparing the price of the Big Mac in different countries, we can see which countries currencies are currently under- or over-valued.
But the theory does have some flaws. While sesame seeds might be cheaper in China, the cost of transporting them to America might eliminate any profits. And there are import taxes, too. It's not just the ingredients that matter. The price of labor and rent is different from country to country. And even if you can import all the goods, unless you're McDonalds, you can't sell Big Macs.
So what can you use the Big Mac Index for? If you're an economist it still gives some indication how exchange rates will move in the long run. If you're a consumer it gives you a rough idea of prices in other countries and how far your money will go. And if you're really into Big Macs, it's your travel guide.