Last Updated on Monday, 22 February 2010 06:34 Written by admin Monday, 22 February 2010 06:34
What is a tradable good?
A tradable good is a good that can easily be sold in a location other than where it was produced. Tradable and non-tradable goods do not fall into two distinct categories but rather they fall on a continuum with some goods being perfectly tradable (like a share of stock or currency), some being perfectly untradable (like a haircut), and most other goods falling somewhere in the middle. Prepared food is not usually considered a tradable good because it’s hard to transport.
What factors contribute to a good’s “tradability” or lack of “tradability”?
Goods that have long shelf lives, and less transportation costs are typically thought of as tradable. Likewise, goods that perish quickly or are cumbersome or very expensive to transport fall on the “non-tradable” end of the spectrum.
What does this have to do with the Big Mac Index?
Non-tradable goods are less subject to the “law of one price” than tradable goods. Another way of saying that is that Purchasing Power Parity does not necessarily hold for non-tradable goods since the opportunity for arbitrage are less. For PPP (and the law of one price) to hold, there must be an effecient market like the foreign exhange market or a stock market. This doesn’t mean that the Big Mac Index is an ineffective measure of PPP or the value of currencies. It simply means that the Big Mac Index, like any other measure of economic comparison is subject to limitations and should be thought of as such.
Learn MoreLast Updated on Monday, 22 February 2010 06:39 Written by admin Monday, 22 February 2010 06:15
The Big Mac Index is based on the concept of Purchasing Power Parity (PPP). That said, PPP holds better in situations where the costs of transporting the good are small or non-existent. This opens up the opportunity for arbitrage which is basically buying a good in a place where it’s cheap and selling it in a place where it’s expensive. This is easy for things like currency but much harder for things like Big Macs. Arbitrage doesn’t exactly work with perishable items.
That said, PPP should still hold to some extent because even if the Big Mac as a finished project isn’t likely to be bought and sold. Laurie Peterson argues in the the article “Real or Rediculous: The Big Mac Index” that in fact PPP doesn’t hold as well as expected in the Big Mac Index because the components on the Big Mac are “non-tradables“. As a matter of clarity, “non-tradables” are things that are unlikely to be imported or exported like services or real-estate.
The Big Mac Index is useful for travelers, giving a good idea about which countries are “expensive,” and which are not, says economics professor Robert Barsky from the University of Michigan. For example, if you’re traveling to Australia this year, plan on paying $4 for the double beef patty sandwich.
“It is less clear, however, that a pop index is a good predictor of changes in the exchange rate over time,” Barsky adds, because “the Big Mac is in large measure, a measure of the non-tradable component of the Consumer Price Index. There is no strong reason that the prices of non-tradables should be equalized across countries.”
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The fact that Big Macs are standardized across countries is what makes it a relatively effective measure of PPP. The non-tradable nature of the Big Mac however takes away slightly from its predictive nature in regards to the exchange rate.
Learn MoreLast Updated on Sunday, 21 February 2010 12:54 Written by admin Sunday, 21 February 2010 12:37
We’ve all been shocked when traveling to see how expensive or cheap local food is compared to what were used to. These differences can seem even more pronounced when you use the nominal exchange rate (dollars per pound or yen per dollar etc). If however you use a PPP adjusted exchange rate like the Big Mac Index (Korean Big Macs vs British Big Macs) the differences will seem less. This story from the Korea Herald compares nominal exchange rates and PPP adjusted exchange rates using Korean restaurant prices in London.
Big Mac Index helps compare London hansik
Glancing at a menu in a Korean restaurant in London, many would be horrified by the price - especially when they are comparing it to those in Korea.
Where doenjang jjigae - or bean paste soup - may cost 4,000 won ($3.40) in Korea, in London it can cost nearly three times as much at 6 pounds ($9.40).
However, when using the “Big Mac Index” - a light-hearted invention of the Economist designed to give a more accurate picture of prices in differrent currencies - Korean restaurants in London do not seem that bad.
The index takes the price of a McDonald’s Big Mac in various countries to give a better economic indicator of purchasing power. The cost of everything is higher in London: A single journey on the London Underground can cost 4 pounds ($6.20) and an umbrella, which is often needed, can easily cost around 10 pounds ($15.60).
When it comes to setting up Korean restaurants, their rent is higher, ingredients more expensive, and average wages are also higher in London (even when you take out the bonuses of the city’s bankers).
Using the Big Mac scale, which takes into account the cost of living, the prices of Korean dishes in London are on a par with those in Seoul. In fact, a Big Mac meal costs about the same as doenjang jjigae in both cities.