Burgernomics The Big Mac Index NERC March 13

Burgernomics! • The Big Mac Index NERC March 13, 2006 Judy Heine Retired, Canton (MA) & MA Council on Econ Ed

The Big Mac Index or “Burgernomics”

The Big Mac Index or “Burgernomics” • Created by ‘The Economist’ in 1986 • Tracks 20 yrs of data • Published Quarterly!

The Big Mac Index * Big Mac has same recipe (ingredients) in 120 countries * So, Big Mac SHOULD cost same in each country but it Doesn’t!!

The Big Mac Index * Based on notion that a dollar should buy the same amount in all countries (Purchasing Power Parity or PPP) * In the long run, exchange rates between two currencies should move towards the rate that equals the price of an identical basket of goods & services in each country

Big Mac Index • Purchasing Power Parity (PPP) is a measure of the relative purchasing power of different currencies. • PPP is measured by the price of the same goods in different countries, compared to the product in the ‘base currency’ • Big Mac Index compares Big Mac prices in US Dollars to price in other nations

Big Mac Index • Visual display created quarterly by The Economist • Comparing, over time, shows changes in strength of currencies

Big Mac Index • Currency values fluctuate daily • Measures one currency in relation to another • Can compare price of Big Mac in another nation to that in USA!

Big Mac Index Comparing a currency’s actual exchange rate with its PPP is one test of whether the currency is undervalued or overvalued.

Big Mac Index Is other nation’s currency: * OVERVALUED? Costs MORE to buy Big Mac than in USA or * UNDERVALUED? Costs LESS to buy Big Mac than in USA

Making Your OWN Big Mac Index Formula: #1 Derive PPP Foreign Price = PPP US Price

Making Your OWN Big Mac Index Formula: #2 To determine if Currency is overvalued or undervalued against US Dollar (PPP-Exchange Rate) X 100 Exchange Rate

What can be learned from Big Mac Index? • Emerging nations have weak currencies • Expensive for them to buy from nations with strong currencies • Expensive for US to buy from nations with overvalued currency

What can be learned from Big Mac Index? Implications for Foreign Trade: Can US sell to other nations easily if their currencies are: Undervalued? Overvalued?

The Big Mac Index (or “Burgernomics”) seeks to make Exchange Rate theory more “Digestable. ”

Big Mac Index • May be ‘hard to swallow’ for some • PPP holds true in longrun even if: --- local prices distorted by trade --- barriers on beef --- sales taxes or difference in property rents!

Big Mac Index • Doesn’t compare real purchasing power of currencies around the world! • USB has created another index that aims to measure well-being by estimating # minutes workers in various countries must toil to buy a Big Mac – EX: Kenya = 3 hours USA = 10 minutes! Differences reflect variations in productivity and disparity in cost of ingredients

Burgernomics! •