Big Mac Index Data

I recently received a question regarding Purchasing Power Parity as it relates to the Big Mac Index.  Most of the Economist's charts include a column labeled "Implied PPP of the Dollar" which is then compared to the "Actual $ Exchange Rate". 

One way to think about PPP in relation to the Big Mac Index is to consider that if a Big Mac in Argentina costs 14 pesos (use local currency for PPP calculations) and a Big Mac in the United States costs $3.73 (data from 2010 Big Mac Index), then 14 Argentinian Pesos and $3.73 should be of equivalent value. 

If in fact this is true, then a dollar should be able to buy 3.75 pesos, another way of saying that $1 and 3.75 pesos are of equivalent value.  In this case, the 3.75 is the "Implied PPP of the Dollar".  The Big Mac prices "imply" that the Purchasing Power Parity of the dollar is 3.75 pesos.  In other words, one dollar and 3.75 pesos should have the same Purchasing Power Parity, and in fact do in terms of Big Macs. 

                                                    Implied PPP of the Dollar

                                                                                =

        Price of Big Mac in local currency / Price of Big Mac in Dollars

As you can see, when you divide the price of a Big Mac in local currency by the price of a Big Mac in dollars and end up with an "Implied PPP of the Dollar", you are actually coming up with a type of exchange rate.  In 2010, according to the price of Big Macs, the exchange rate "should" have been 3.75 pesos per dollar.  In reality, the exchange rate was 3.93 pesos per dollar which means that in 2010, the Argentinian Peso was undervalued by about 5%.  

I'll elaborate on that in a later post.  Please feel free to leave comments below or here.  Take care.