My take on the Big Mac Index---the Big Mac Inflation Index. Am I onto something???

The Economist is out with its latest update on the Big Mac Index.  It is a playful illustration of the exchange rates and Purchasing Power Parity given just one commodity--McDonald's Big Mac.  Find out more about it HERE.

When I looked at the historical data available with the index I noticed in some countries the price of a Big Mac had changed quite a bit.

So I took the posted prices in the countries own currency from January 2012 (3rd column) and January 2014 (2nd column) and calculated the percent change in price of Big Mac (4th column).

The numbers are in descending order, from highest to lowest change in price.

I highlighted in RED the countries where the percentage price change was higher than the world wide average change in price of 9.28%.

Here is an assignment for you.  Check a few of the countries ACTUAL inflation rates and see how they correlate to the change in prices of Big Macs.   Maybe we have discovered a new fun measure of inflation---The Big Mac Inflation Index.  Just  send me some royalties. That's all I ask for.  :)

The latest Big Mac Index is out...See how much it costs around the world...

The latest Big Mac Index from The Economist is out.  At current (July 2011) exchange rates you can see how much in US dollars it takes to buy McDonald's signature sandwich in various countries around the world---look at the column to the right. The horizontal bars indicate in percentage terms how much that countries currency is overvalued or undervalued relative to Purchasing Power Parity (PPP).  PPP suggests that in the "long run" the ACTUAL published market exchange rate between two currencies (say, the Norwegian Krone at $1.00 = 5.41 Kroners--July 28th) should equal the ratio of the price of a Big Mac in Krones divided by the price of a Big Mac in Dollars (45 Kroners/$4.07 = 11.06). At PPP we would get 11.06 Kroners for each dollar exchanged, but at real world rates we are getting only 5.41 Kroners. We are paying a little over double the suggested PPP exchange rate, hence the blue bar (calculate percentage change--PPP exchange rate minus the Actual exchange rate divided by the Actual exchange rate times 100) and the implication that the Krone is OVERVALUED (+) relative to the dollar. 

The Big Mac is only one product sold in each of the countries and there are many factors that effect exchange rates. A fun exercise would be to find another closely related good and do a similar comparison.  Sounds like a homework project to me...

According to the latest Big Mac Index, the Chinese Yuan has Appreciated in value relative to the dollar by 20%!...This should be BIG news in the Media, right??

     Here is the latest "Big Mac Index"(graphic below) produced by The Economist magazine AND one produced in January 2010 (click HERE and HERE for my explanations of how The Big Mac Index works).  Look at the cost of a Big Mac in the Euro area and then in China. How has the dollar price of a Big Mac changed in 9 months in each place?  In January it took $4.79 to buy one in the Euro area (they took a weighted average) and in October it took $4.84 to buy one.  So in dollar terms it became MORE expensive to buy a Big Mac. This implies the dollar lost value, or depreciated, relative to the Euro.  Indeed, depreciation relative to the Euro has taken place this year.  In China, a Big Mac cost $1.83 in January and in October it cost $2.18 (this is the amount we would give up to buy enough Yuan to purchase a Big Mac in Beijing).  This implies the dollar lost value, or depreciated, relative to the Yuan (Chinese currency). SAY WHAT? This is NOT what has been the political discussion as of late.  China has been criticized for NOT letting its currency appreciate relative to the dollar (as it SHOULD if it was traded in a flexible FOREX market) which would make its goods and services more expensive for us to buy and our goods and services less expensive for the Chinese to buy.  This presumably would lead to more balanced trade. 
     According to the Big Mac Index, from the two different time periods, Yuan appreciation HAS occurred. The dollar price of a Big Mac in China has INCREASED 19.6% ($2.18 minus $1.83 = $.35 divided by $1.83 times 100)!!  The following could be happening: the Yuan has significantly appreciated in value, which would be BIG news, or there is Big Mac Inflation in China, or a combination of the two. We certainly have not seen nearly 20% appreciation, so I have to suspect inflation. One product does not make a trend, but is inflation rearing its ugly head in China?  I pulled the thread---extra credit for doing the legwork to find out if this is the case...  

 

The Economist



Here is one previously published in January 2010:

Note: the price of a Big Mac increased in the US, from $3.58 to $3.71, which is an increase of 3.6%. Can we say we have had inflation in the US for the last 9 month? No...so what else might contribute to the price increases in the US AND China for the Great Sandwich??  Extra-Extra Credit!!

What does a Big Mac have in common with an IPOD???

Just found this.  See how much it costs to buy an IPOD in different countries.  It is somewhat similiar to The Economist magazines "Big Mac Index".  The price of  IPOD in the US is $149.00...As an example, look at Argentina.  The Peso price of an IPOD Nano (8G) is 1,299 Pesos (from Apple website HERE)...The PPP exchange rate would be 1,299 Pesos divided by $149 = 8.72 Pesos ($1.00 = 8.72 Pesos) The ACTUAL exchange rate is $1.00 exchanges for 3.90Pesos.  So if you divide 1,299 Pesos by 3.90 Pesos ($1.00 buys 3.90 Pesos) you get a dollar price of $333.07 for the IPOD (slightly different than the price below...exchange rate change since Oct 2009). VERY expensive IPOD in Argentina!!

CommSec iPod nano index


8 gigabytes, October 2009

$US                                                $US

Argentina $336.43                   Malta $207.15

Brazil $333.56                         Spain $207.15

Iceland $320.95                      Portugal $207.15

South Africa $283.65              Italy $207.15

Hungary $278.42                    Belgium $207.15

Vietnam $275.56                    Ireland $207.15

Egypt $269.43                       Germany $207.15

Uruguay $265.00                   El salvador $199.00

Serbia $254.99                       Guatamela $198.11

Czech $253.29                       Costa Rica $197.45
         
Ukraine $248.00                     Luxembourg $196.89

Croatia $246.73                      Switzerland $195.37

Romania $236.65                    Taiwan $194.14

Bulgaria $234.34                     Greece $194.11

Lithuania $233.33                    Korea $194.05

Chile $231.68                          NZ $191.80

Finland $231.00                       India $191.75

Slovenia $231.00                     Peru $188.47

Estonia $230.63                       Philippines $188.06

Latvia $229.84                          UK $188.03

Norway $222.45                      Thailand $182.76

Austria $222.06                       Australia $182.28

France $222.06                       Pakistan $179.98

Slovakia $222.06                    Mexico $178.90

Denmark $219.80                   UAE $176.65

Russia $218.26                      Turkey $175.84

Sweden $214.41                    Malaysia $175.43

Indonesia $212.69                  China $175.22

Azerbaijan $210.46                Saudi Arabia $170.22

Cyprus $208.63                     Singapore $163.69

Israel $208.50                        Canada $162.88

Sri lanka $208.42                    Japan $162.76

Poland $208.22                      Hong Kong $150.68

Netherlands $207.15             US $149.00

Source: CommSec, Apple

Big Mac Index Explained----

The Big Mac Index is a creation of The Economist magazine...It is a measurement of an important economic concept called Purchasing Power Parity, or "PPP" for short.  PPP suggests that over time the prices of similar goods SHOULD be relatively EQUAL in terms of the purchasing power of the local currency it takes to buy it, REGARDLESS of the currency or country it is sold in.  It is by no means a perfect measurment and there are many variables that may account for differences in costs of producing a Big Mac in, say, New York compared to Mexico City. However, it gives as some idea of what exchanges SHOULD be and then we can compare them to what the REALLY are in the Foreign Exchange Market and determine if currencies are over-valued or under-valuded relative to each other....Here is an example:

The Economist uses a Big Mac price of $3.57 in the US. A Big Mac in the Euro area costs €3.31. If we take the Big Mac in Euros divided  by the price in Dollars we will get a PPP exchange rate of Euros in terms of Dollars---€3.31/$3.57 = €.927.  This means, according to PPP, $1.00 will exchange for €.927 and the reciprocal, €1.00 will exchange for $1.078.  What is the ACTUAL exchange rate in the FOREX?---$1.00 = €.739 or €1.00 = $1.353. To find out what a Big Mac will actually cost dollar holders, we take the Big Mac price in euros, €3.31, and multiply it by actual exchange rate of $1.353 which equals $4.48! AND if a holder of Euros exchanges their Euros for Dollars to buy a Big Mac in the US, they will pay $3.57 multiplied by the actual exchange rate of €.739 which equals $2.69! Not a deal for holders of dollars BUT a deal for holders of Euros....

The basic formulas you need to know...
(1) To find PPP take the Big Mac Price in the local currency and divide it by the Big Mac Price in Dollars ($3.57 everytime)
(2) This will give the foreign currency price per dollar (in PPP), or "How many ___(insert name of currency) does it take to buy $1.00".
(3) Take the reciprocal of the number you found in (2) to determine "How many dollars does it take to buy___(insert name of currency)"
(4)...(2) and (3) give you the PPP exchange rate
(5) Find the ACTUAL exchange rate for (1) a dollar to buy ___(corresponding currency) and  (2)___(corresponding currency) to buy a dollar. In our example above--a dollar bought €.739 and a euro bought $1.35.
(6) Take the actual exchange rate for a holder of dollars (in our example we had to pay $1.353) to buy the currency and mulitply it by the Big Mac price in the foreign country to get how much in dollars the Big Mac will cost you.
(7) Take the actual exchange rate for the foreign currency (in our example they had to pay €.739) to buy a dollar and multiply it by the Big Mac price in the US (always $3.57) to find out how much in dollars it will cost the foreigner to buy a Big Mac in the US.

Examples for you to work:
Country          Price of Big Mac in this country
Mexico             33 Pesos
China               12.5 Yuan
Britain              2.29 Pounds
Norway            40 Kroner
S. Korea           3400 Won
Pakistan            190 Rupee
Japan                320 Yen

Go through each question above, 1-7 and answer accordingly
To check your work CLICK HERE.
Go HERE for current exchange rates