The Big-Mac Index

The Big Mac index is based on the theory of purchasing power parity, according to which exchange rates should adjust to equalise the price of the basket of goods and services around the world. The basket in question is: the Big-Mac burger.

The notion of of the PPP is that a dollar should buy the same amount in all countries, and in the long run - the two countries shall move towards a rate that equalises the prices of an identical basket of goods and services. Now consider that all currencies will try to balance this delicate equation and tend towards a singly acceptable equation which would read something like :
aC1 = bC2 = cC3 = dC4 = ..... = nCn (really long term)

Lets take an example from the table below :
The price of Big-Mac in China (remember some news stories on the move to banish McDonald's from the forbidden city) is 11.0 Yuan which translates to 1.41 USD (7.77 Yuan = 1 USD). However the PPP calculation of the Chinese Big Mac (as compared to the US) would be 3.42 (i.e. 11.0 Yuan / 3.22 USD). This means, the Yuan in the long run will be valued at around 3.42 to the dollar .. while the current Yuan/USD fx rate is 7.77 ... indicating a possible 56% appreciation in the Yuan w.r.t. the dollar.


While the interplay between developed and developing/under-developed countries may not be too good for comfort, the difference in the Yen and USD is really appalling. The current exchange rate is 121.0 and the Big-Mac parity is at 87.0 (a big difference of 28%)