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Big Mac index
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Big Mac index

The Big Mac index is an informal way of measuring whether one currency is at the theoretically correct exchange rate with another currency. The measure assumes that the theory of purchasing power parity (PPP) holds.

The central idea tenet of PPP is that the exchange rates between two currencies should naturally adjust so that the cost of a sample basket of goods should cost the same in one currency. In the Big Mac index, the "basket" in question is considered to be a single Big Mac as sold by the McDonald's fast food restaurant chain. The Big Mac was chosen because it is available to a common specification in many countries around the world, with local McDonald's franchisees having significant responsibility for negotiating input prices. For these reasons, the index allows for meaningful comparison between many countries' currencies.

The Big Mac PPP exchange rate between two countries is obtained by dividing the cost of a Big Mac in one country (in its currency) by the cost of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.

For example, suppose a Big Mac costs 2.00 in the United Kingdom and $2.50 in the United States; thus, the PPP rate is 2.00/2.50 = 0.8. If, in fact, the dollar buys 0.55, then the pound is over-valued with the respect to the dollar.

The Big Mac index was introduced by The Economist newspaper in September 1986 and has been published by that paper more or less annually since then. The index also gave rise to the word Burgernomics.

In January 2004, The Economist introduced a sister Tall Latte index. The idea is the same, except that the Big Mac is replaced by a cup of Starbucks coffee, acknowledging the global spread of that chain in recent years. In a similar vein, in 1997, the newspaper drew up a "Coca-Cola map" that showed a strong positive correlation between the amount of Coke consumed per capita in a country and that country's wealth.

The burger methodology has limitations in its estimates of the PPP. For example, local taxes, rates, levels of competition, and import duties for burgers may not be representative of the country's economy as a whole. Nevertheless, the Big Mac index has become widely cited by economists.

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