THE BIG MAC INDEX CONCEPT

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THE BIG MAC INDEX CONCEPT


Given the consistency of McDonald’s Big Mac product across countries, its price is used by The Economist to calculate exchange rates adjusted for purchasing power for a sample of countries. The idea of the Big Mac as a measure of purchasing power parity is based on the Law of One Price, according to which the exchange rate should adjust to equate prices of the same products between countries. By comparing the price of a Big Mac in any two cities in different countries, the exchange rate can be readily calculated that would make the prices equal For example (as shown below), if a Big Mac costs US$2.90 in the United States and 10.41 yuan in China, then the exchange rate should be 3.59 yuan per U.S. dollar, so that the same Big Mac costs the same in New York and Shanghai.

Calculating the Big Mac PPP rate

PPP Yuan/US$ = Chinese price of a Big Mac in yuan divided by U.S. price of a Big Mac in US$
= Yuan10.40 / US$2.90 = 3.59 Yuan/US$, which is the exchange rate that will exist if the Law of One Price holds exactly The above example makes it clear that the calculation of purchasing power parity is based on equal prices in both countries, rather than necessarily equal purchasing power for consumers. Given that the average per capita income in China in 2004 was US$5,225, while in the U.S. the average was US$34,770, it is clear that Chinese would not have the same purchasing power as the average American in that year. It would cost a Chinese consumer about 6.5 times as much as a percentage of his/her income to buy a Big Mac, even if the price were the same in both countries. Not surprisingly, a Big Mac costing 10.40 yuan in China may very well be a luxury good. In fact, in many countries, this is exactly the case.

Big Mac Big Mac Implied Actual dollar Under
(-)/over (+)
prices in local pricess in PPP of exchange rate valuation against
currency dollars the dollar May 2004 the dollar (%)
 
THE BIG MAC INDEX CONCEPT


Given the consistency of McDonald’s Big Mac product across countries, its price is used by The Economist to calculate exchange rates adjusted for purchasing power for a sample of countries. The idea of the Big Mac as a measure of purchasing power parity is based on the Law of One Price, according to which the exchange rate should adjust to equate prices of the same products between countries. By comparing the price of a Big Mac in any two cities in different countries, the exchange rate can be readily calculated that would make the prices equal For example (as shown below), if a Big Mac costs US$2.90 in the United States and 10.41 yuan in China, then the exchange rate should be 3.59 yuan per U.S. dollar, so that the same Big Mac costs the same in New York and Shanghai.

Calculating the Big Mac PPP rate

PPP Yuan/US$ = Chinese price of a Big Mac in yuan divided by U.S. price of a Big Mac in US$
= Yuan10.40 / US$2.90 = 3.59 Yuan/US$, which is the exchange rate that will exist if the Law of One Price holds exactly The above example makes it clear that the calculation of purchasing power parity is based on equal prices in both countries, rather than necessarily equal purchasing power for consumers. Given that the average per capita income in China in 2004 was US$5,225, while in the U.S. the average was US$34,770, it is clear that Chinese would not have the same purchasing power as the average American in that year. It would cost a Chinese consumer about 6.5 times as much as a percentage of his/her income to buy a Big Mac, even if the price were the same in both countries. Not surprisingly, a Big Mac costing 10.40 yuan in China may very well be a luxury good. In fact, in many countries, this is exactly the case.

Big Mac Big Mac Implied Actual dollar Under
(-)/over (+)
prices in local pricess in PPP of exchange rate valuation against
currency dollars the dollar May 2004 the dollar (%)

Hey, thanks for your help and sharing the information on THE BIG MAC INDEX CONCEPT. Well, i have also a document and uploading it where you would get more information on THE BIG MAC INDEX CONCEPT.
 

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