What is the Big Mac Index
In the exciting world of economics and finance, there are multiple indicators and tools that experts use to understand and evaluate the economic health of a country.
One of the most unusual and, at the same time, effective, is the Big Mac Index, a concept that was created in 1986 by The Economis t to simplify the understanding of a topic as complex as purchasing power parity (PPP).
In this article, we will explore in detail what the Big Mac Index is, how it works, and why it has become a global reference for analyzing differences in currency values between countries.
What is the Big Mac Index?
The Big Mac Index, or Big Mac Index in Spanish, is an economic indicator that aims to compare the different currencies of the world in terms of their purchasing power. In other words, it seeks to answer the question: "how much can you buy in one country with the same amount of money you need to buy a Big Mac hamburger in the United States?"
This simple question hides a series of fundamental economic concepts that help us understand how currencies behave in the global market.
Purchasing power parity (PPP)
To fully understand the Big Mac Index, it is essential to understand the concept of purchasing power parity. PPP is an economic theory that suggests that, in an ideal world without transaction costs, identical goods should have the same price in two countries when expressed in the same currency.
In other words, a Big Mac in the United States should have the same price in dollars as in any other country in its local currency if PPP were strictly applied.
However, in reality, this rarely happens due to a number of factors, such as differences in labor costs, taxes, regulations, and the supply and demand of local products.
This is where the Big Mac Index comes into play, as a tool that helps us identify discrepancies between the real price of a Big Mac in different countries and the theoretical price it should have according to the PPP.
Why the Big Mac?
You might wonder why a Big Mac burger was specifically chosen for this index. The answer is that McDonald's Big Mac is a globally recognized and standardized product.
All over the planet, a Big Mac has the same ingredients and, generally, the same flavor. This makes it an ideal product for comparing the purchasing power of people in different countries.
The Big Mac burger includes common items found in most basic food baskets, such as bun, meat, lettuce, onion, cheese, and other ingredients.
By having a common comparison product, the Big Mac Index provides us with a quick and easy view of how fluctuations in exchange rates affect the purchasing power of a currency compared to the US dollar.
Practical examples of the Big Mac Index
To better understand how the Big Mac Index works in practice, let's consider a couple of examples. In December 2022, a Big Mac cost 18,900 pesos in Colombia and $5.36 in the United States.
This resulted in an implicit exchange rate of 3,526 pesos per dollar. However, the real exchange rate at that time was 4,545 pesos per dollar. What does this tell us?
The difference between the implicit exchange rate and the real exchange rate suggests that the Colombian peso was undervalued by 22.4%. In other words, with 18,900 Colombian pesos, you could buy a Big Mac in Colombia, but if you traveled to the United States and converted your Colombian pesos at the real exchange rate, you would get $0.78.
This discrepancy reflects that the purchasing power of the Colombian peso was weaker than the official exchange rate indicated.
Fast forward one year to July 2023. Surprisingly, a Big Mac still costs 18,900 pesos in Colombia, but in the United States, the price has risen slightly to an average of $5.65. The implied exchange rate is now 3,345 pesos, while the actual exchange rate is 3,978 pesos. This implies that the Colombian peso is still undervalued by 15.9%.
At first glance, the difference between 0.78 hamburgers and 0.84 hamburgers may seem insignificant. However, when we extrapolate this discrepancy to higher-value products, such as cars, machinery, or even clothing, the implications become more significant.
This means that Colombians still have a competitive advantage in terms of costs compared to Americans when it comes to purchasing a Big Mac burger.
Economic and commercial implications
The Big Mac Index, although it may seem like a curious and simple tool, has important economic and commercial implications.
It helps investors, businesses and governments understand how different countries' currencies are valued relative to the US dollar, a global benchmark currency.
When a currency is undervalued, as in the case of the Colombian peso, it can make that country's products and services more attractive to foreigners, which can boost exports and tourism.
On the other hand, an overvalued currency can make it difficult to export domestic products, as foreigners find them more expensive in relative terms.
Conclusion
The Big Mac Index is much more than just a price comparison of burgers around the world. It is an ingenious economic tool that helps us understand how currencies work in relation to the US dollar and how these differences affect the purchasing power of people in different countries.
Through practical examples, we have seen how the Big Mac Index can reveal imbalances in exchange rates and have a significant impact on the economy and international trade.
Written by Moises Hamui Abadi: I am an entrepreneur, founding partner of Viceversa and SoyMacho. After leading several digital businesses and advising several other businesses; I decided to form MHA Consulting, a digital marketing consultancy dedicated to growing and enhancing digital businesses in more than 7 countries and generating more than 1,500 million pesos.
If you want more information on this topic or are looking for other options to profile your ideal client, at MHA you will find the solution you need. Schedule a call.