The Big Mac Index for 2015 was published on January 22nd, 2015. Based on the previous years, The Economist will probably publish another version in July 2015. If are looking to get the entire dataset going back to 1986, click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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If you have spent any amount of time with the Big Mac Index, then you have certainly come across the term “Purchasing Power Parity”. The Economist’s official Big Mac Index page states that the Big Mac Index is “based on the theory of purchasing-power parity (PPP)” but what does that mean? The short answer is that over the long run, currencies should equalize in value (or tend toward parity) with each other.
So what does this mean in terms of Big Macs and dollars? Well let’s look at some actual data from the 2013 Big Mac Index … specifically the price of a Big Mac in the United States (U.S. Dollar), China (Chinese Yuan), and Colombia (Colombian Peso). I’ve chosen these countries because in 2013, China’s currency undervalued according to the dollar, the U.S. dollar has traditionally been the “benchmark” currency in the Big Mac Index, and Colombia’s currency is overvalued slightly according to the dollar.
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Let’s say you start with $4.20. That’s enough to buy a single Big Mac in the United States. So what happens if we convert that dollar to Chinese Yuan? We end up with 26.54 yuan which is enough to buy 1.72 Big Macs! This means that the dollar is a stronger currency. As a side note, China is notorious for keeping the value of their currency low in order to encourage exports and this is a a mini example of how that makes sense. Someone in the United States could take their dollars and instead of getting a single Big Mac, buy 1.72 Big Macs just by converting their currency to Yuan. In effect, export 1.72 Big Macs to the United States because they are cheaper there … put another way, the dollar goes farther there. The Yuan is undervalued against the dollar by about 42%.
Now let’s take our $4.20 and instead of converting it to Chinese Yuan, we will convert it to Colombian Pesos. After the conversion we will have 7779 pesos which is only enough to buy .93 of a Big Mac. It’s close to a full Big Mac but not quite there which is why the Colombian Peso is overvalued against the dollar but only by about 8%.
In short …
… or using the data above
The longer explanation …
The way the Economist phrases it is a little bit confusing. For this column in the tables, just think of keeping the price of the Big Mac constant. It’s like saying, “Since 8400 Colombian Pesos AND $4.20 U.S. Dollars can both buy me a Big Mac, then they should have the same value”. According to Purchasing Power Parity, the price of a Big Mac SHOULD remain constant in any country based on the current exchange rate. In other words, your $4.20 once converted to any other currency SHOULD buy you exactly one Big Mac. In the case of U.S Dollars and Colombian Pesos, that would imply that $4.20 and 8400 Colombian Pesos have the exact same value (assuming as we are that the price of a Big Mac is the value that is held constant).
There are actually two answers to this question. The first is that although the Big Mac makes sense as a substitution for a “basket of goods” it is not a perfect “basket”. In reality, no basket of goods is perfect. Maybe China is actually more efficient at producing a Big Mac and Colombia is less efficient thereby necessitating a lower or higher price.
The second reason is that for policy reasons, countries will take actions to either devalue or increase the value of their currencies. Generally a lower currency value encourages exports and a higher currency value encourages internal consumption (buying). This topic is far deeper than I intend to cover here but in short, a country can take it’s own currency and buy dollars in order to weaken it’s own currency and strengthen the dollar (or whatever currency they are buying). Since the dollar has been the world’s reserve currency for quite a while, many countries have bought dollars to store a foreign reserves. This increases the demand for the dollar and a simple supply and demand calculation shows that this increases the value of the dollar while decreasing the value of the purchasing currency.
Also, as of now the dollar is still used to settle many international monetary transactions which increases demand for the dollar. When there are more sellers of an item than buyers (even a currency), it’s value goes down.
I hope that this post helps to explain a little bit more about Purchasing Power Parity and some background on why there are such huge differences in the value of currencies. Please post below or contact me if you have any questions
The Big Mac Index was published both in July and January 2014. The July 2014 Big Mac Index is shown below. If are looking to get the entire dataset going back to 1986, click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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The Big Mac Index was published both in January and July of 2014. The January 2014 Big Mac Index is shown below. If are looking to get the entire dataset going back to 1986, click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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The Big Mac Index was published in January 2014 and July 2014, both are shown below. If are looking to get the entire dataset going back to 1986, click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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The Big Mac Index was published both in July and January 2013. The July 2013 Big Mac Index is shown below. If are looking to get the entire dataset going back to 1986, click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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1. Searched Craigslist for home sellers willing to sell their house on a land contract and eventually found one that made financial sense (see below for details on land contracts).
2. Borrowed $5,000 from my parents and used $10,000 that I had saved up as a down payment. The sale price was $54,000 so the remaining $39,000 was on the land contract.
3. Since the interest rate on the land contract was 7%, I paid it off as soon as possible using student loans (see below for issues relating to using student loans as a down payment or for paying off real estate purchases).
4. Found a renter (also using Craigslist) who rented the house for $950 / month. The $950 covered the land contract payment, property tax, insurance, and the payments on the loan from my parents.
The Big Mac Index was published both in January and July 2013. The January 2013 Big Mac Index is shown below. If are looking to get the entire dataset going back to 1986, click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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The Big Mac Index was published in January 2013 and July 2013, both are shown below. Click here to download the complete spreadsheet. Big Mac Index information is from the Economist, click here for the Kindle version of the Economist.
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