June 17th 2005
Big Mac Index tests PPP
Economic theory, specifically the Law of Purchasing Power Parity (PPP) dictates the value of a particular currency should reflect its purchasing power. Basically, different prices in different countries should be corrected by exchange rates. Empirical evidence has shown that PPP does hold in the long run, although it often takes several years for currencies to move towards ‘equilbirum.’ Since 1986, the Economist has used the Big Mac Hamburger as a means of testing the theory of purchasing power parity. Every week, the magazine publishes a listing of Big Mac prices, which often vary by country. The law of PPP holds the prices should be comparable across different countries, when converted into USD. To be fair, though, one must take local variations in the cost of inputs into account. According to the Big Mac Index, Switzerland’s currency is the most expensive, and the Chinese Yuan is the cheapest.
