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The Big Mac Index

big-mac-index

Burgers as a Benchmark for Trading

What idea comes to mind when you read The Big Mac Index. For most, you would think of McDonalds’ insignificant index list of boring burgers, or perhaps, the binary of the friendly and scary looking clown, Ronald McDonald.

After all, I guess this shows that McDonalds’ advertising and PR may be way more catchy and ‘addictive’ than their food. Though, for those interested in finance, this Big Mac Index may be more important than just a mere burger.

The Big Mac Index does indeed refer directly to the McDonalds‘ “Big Mac”. McDonald’s is a huge worldwide chain making its mark over 70 – 80% of the globe. The McDonald’s Big Mac is used as a benchmark for economics, which reflects on different currency’s worth and value. They were able to use the Big Mac burger because it sells in every store that exists.

The Economist’s Infamous Annual Survey

When The Economist magazine first introduced The Big Mac Index in 1986, it was intended to be an amusing and entertaining way to calculate Purchasing Power Parity.  Thirty-three years later and this index has become one of the most cited and reliable sites in global standard, which is relied upon by traders and taught in many economic textbooks too.

What is Purchasing Power Parity?

Purchasing Power Parity is an economic theory known as a “basket of goods.” Purchasing Power Parity is used as a guide to calculate whether two compared currencies are in equilibrium. The levels are tested through the lens of a fixed set of consumer products and goods. Two currencies are to be in balance when both placed in the basket and should have the same worth in each country.

In the case of The Big Mac Index, the price of the famous McDonald’s Big Mac is the benchmark used to determine Purchasing Power Parity. The theory states that the exchange rate fluctuations between currencies ultimately affect the price that consumers will end up paying for a hamburger.

The Big Mac Index in Action

To illustrate the theory, let’s consider the following example:

If the cost of a McDonald’s Big Mac is $3.75 in the United States and £2.00 in Great Britain, the exchange rate is expected to be 1.875 ($3.75 /£ 2). If the exchange rate of the dollar rises, The Big Mac Index tells us that the GBP is overvalued. If the exchange rate of the Dollar lowers, the index tells us that the GBP is undervalued.

No Big intentions for the Big Mac

At first, the index was intended to be lighthearted and fun because as it was far from perfect. McDonald’s can influence the index because they decide on the cost of their Big Mac burger. Another glaring imperfection is that the Big Mac burger does not have the same specifications. Each country has its type of Big Mac burger, from its size to ingredients and also to the type of bun.

For traders, The Big Mac Index can be used as a commodity indicator in currency investments.

For an indication of this Index and to see how it is calculated, click on this link to read, which is from MarketWatch, 

 

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