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Sunday, June 12, 2005

big mac index

Magazine The Economist (more recent articles)has been using the Bigmac index as an indicator for currency exchange. See here for a discussion on its relevance to RMB revaluation.

Below is an portion of the discussion copied from Economist.com. Due to copyright issues I should not copy the whole article.

"Burgernomics is based on the theory of purchasing-power parity, the notion that a dollar should buy the same amount in all countries. Thus in the long run, the exchange rate between two currencies should move towards the rate that equalises the prices of an identical basket of goods and services in each country. Our “basket” is a McDonald’s Big Mac, which is produced in about 120 countries. The Big Mac PPP is the exchange rate that would mean hamburgers cost the same in America as abroad. Comparing actual exchange rates with PPPs indicates whether a currency is under- or overvalued.

The first column of the table shows local-currency prices of a Big Mac; the second converts them into dollars. The average price of a Big Mac (including tax) in four American cities is $2.51. The cheapest burger among the countries in the table is once again in Malaysia ($1.19); at the other extreme the most expensive is $3.58 in Israel. This is another way of saying that the Malaysian ringgit is the most undervalued currency (by 53%), and the Israeli shekel the most overvalued (by 43%).



The third column calculates Big Mac PPPs. For instance, dividing the Japanese price by the American one gives a dollar PPP of ¥117. On April 25th the actual rate was ¥106, implying that the yen is 11% overvalued against the dollar.

Despite a single currency, the price of a Big Mac varies considerably within the euro area—from a bargain $2.09 in Spain to a beefy $3.12 in Finland. The average price (weighted by GDPs) in the 11 countries is euro2.56, or $2.37 at current exchange rates. The euro’s Big Mac PPP against the dollar is euro1 = $0.98, which suggests that the euro is 5% undervalued—considerably less than many market commentators claim.

....."


For full coverage from The Economist click here.

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