What Is the Big Mac Index?
The Big Mac Index Explained
The Big Mac Index is an index based on the theory of purchasing power parity (PPP). PPP theory states that, in the long run, currency exchange rates should move toward equalizing the price of a basket of goods and services in different countries. What better basket of goods to explore than a McDonald's Big Mac—with identical ingredients in virtually every country?
Learn more about the Big Mac Index and what it can tell us about purchasing power, local and world economics, and inflation.
What Is the Big Mac Index?
The Big Mac Index is based on PPP theory, which considers the idea of an identical basket of goods and services in different countries. A basket of goods and services in the U.S. would likely look different from what could be found in other countries. However, McDonald's—which operates in 118 countries—provides a control variable with its Big Mac burger.
In theory, the price of a Big Mac reflects a number of local economic factors, ranging from the cost of the ingredients to the cost of local production and advertising. The resulting PPP metric is therefore considered by many economists to be a reasonable measurement of real-world purchasing power.
- Alternate names: Big Mac PPP, Burgernomics
How the Big Mac Index Works
The Big Mac Index is calculated by dividing the price of a Big Mac in one country by the price of a Big Mac in another country in their respective local currencies to arrive at an exchange rate. This exchange rate is then compared to the official exchange rate between the two currencies to determine if either currency is undervalued or overvalued according to the PPP theory.
For example, suppose that a Big Mac in the U.S. costs $1, and a Big Mac in the eurozone costs 2 euros. The Big Mac Index valuation for EUR/USD would be 2.0, or two divided by one, which could then be compared to the EUR/USD exchange rate. If the EUR/USD exchange rate was 1.5, investors might predict that the euro is undervalued by 0.5 euros per U.S. dollar.
The Big Mac Index was developed in 1986 by The Economist, a publication specializing in economics, business, finance, arts, and science.
Variations of the Big Mac Index
There are many variants of the Big Mac Index that may be useful for investors. For instance, UBS Wealth Management expanded the index to factor in the number of hours that an average worker must work to earn enough to buy a Big Mac. Other groups created separate indexes for Apple iPods, Starbucks coffees, Ikea Billy bookcases, and more.
The Consumer Price Index (CPI)—a key measure of inflation—seeks to include all goods. However, some economists believe that certain goods could provide a more accurate indicator because the CPI can be skewed by certain categories or manipulated by some governments.
There is a similar drawback to using the Big Mac Index: It only includes a single item and lacks the diversification seen in other economic indicators that factor in many different products and services.
The Big Mac Index as an Investigative Tool
Investors in the U.S. may not see much need for the Big Mac Index because there are already a number of reputable price indexes available, such as the CPI. But the index becomes useful in other countries where reliable indexes aren't available, including those that manipulate government statistics or those that don't publish official data. In these countries, investors may have trouble comparing consumer inflation to the exchange rate.
Many economists believed that Argentina had been modifying its official consumer price data to understate its true rate of inflation between 2010 and 2012. The Economist used the Big Mac Index to find that the average annual rate of burger inflation was 19% compared to the country's official 10% rate of inflation in January 2011. These insights could have helped international investors get a true idea of inflation when trying to value bonds or other inflation-sensitive securities.
Why the Big Mac Index Is Useful
Investors can use data from the Big Mac Index in many different ways. They can use the values to determine if a currency is overvalued or undervalued relative to others, then trade based on that data in the foreign exchange market. Similarly, investors can measure changes in values over time to determine rates of inflation and compare that to official records.
Investors should use the Big Mac Index as one of the many tools at their disposal when analyzing international markets.
Inflation itself is extremely useful to know when it comes to valuing financial instruments. For example, bond yields must factor in the anticipated rates of inflation to ensure that they will remain attractive in the future. Inflation rates also impact currency valuations, which is important for politicians when determining whether tariffs or other trade barriers are justified.
- The Big Mac Index is an index based on the theory of purchasing power parity (PPP).
- Because a Big Mac should be identical in every country, it provides a control variable for analyzing price differences.
- The Big Mac Index is calculated by dividing the price of a Big Mac in one country by the price of a Big Mac in another country in their respective local currencies to arrive at an exchange rate.
- It can be especially useful in countries where reliable indexes—such as the Consumer Price Index (CPI)—aren't available. These may include countries that manipulate government statistics or don't publish official data.