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How the Big Mac Index helps to value currency

Economics can be a tricky thing to get your head around, but comparing prices of Big Mac’s around the world can help.

This week, The Economist published its yearly Big Mac Index, which compares prices of McDonald’s favourite burger between countries and values their currencies accordingly.

The report suggests that New Zealand’s currency is weaker than it should be and that China’s GDP is bigger than the World Bank currently believes.

You might not think it possible to fully grasp currency values and exchange rates using a Big Mac, but it’s actually been a popular method employed by economists for decades. First invented in 1986, The Economist describes it as a ‘light-hearted guide to whether currencies are at their correct level’ and has been featured regularly ever since.

How does the Big Mac Index work?

The index is based on an economic theory called purchasing power parity (PPP) whereby currencies are compared using a ‘basket of goods’ that consists of various products and services. If the same basket of goods cost $100 in the US and £200 in the UK, for example, then the purchasing power parity exchange rate is 1 to 2. The Big Mac Index uses this model, but the ‘basket of goods’ is just a Bic Mac.

To get the exact exchange rate between two countries, you need to divide one country’s Big Mac price with another. This resulting number is then compared to the actual exchange rate between the two countries, and if the Big Mac exchange rate is higher then the first country’s currency is overvalued. Still with me?

This approach has been labelled as ‘burgeronomics’ which sounds a little like something out of a SpongeBob skit but is very real. You can view The Economist’s in-depth tool here to see different currency values from around the world. It also makes me hungry, which is not something I ever thought I’d associated with in-depth economic charts.

Is this a good model to use?

Big Macs are used because they’re one of the most internationally understood products – nearly every nation on Earth has its own version with few variations. It’s also never gone out of style and is still relevant today, allowing yearly comparisons that help to better understand currency fluctuations.

It’s not a perfect system, however. McDonalds as a brand is valued differently from country to country. In some nations it’s considered a cheaper fast food option, whereas in places such as Norway an average meal is valued at over $20. This isn’t necessarily a reflection of each countries inflation rates or currencies values, but rather McDonalds’ differing market status in separate places.

Big Macs also vary in price within a country. Buying one in London will be more expensive than, say, rural Devon, and the Bic Mac Index doesn’t take into account other factors like production costs, transport costs, and advertising budgets that will affect the overall price of a burger outside of currency rates.

It is a useful and accessible system for people who aren’t the most clued up on economic systems though, of which I am guilty. The Big Mac is also one of the most sensible products to create this comparison despite some of its flaws, as you’ll be hard pressed to find many other items or services that are available nearly everywhere.

Next time you pop into your local fast food place you may want to ponder on the value your burger has in the wider context of your country’s economic status. Or choose the vegan option, which is definitely preferred in our books.