Non-Tradables and the Big Mac Index

Last 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.