Big Mac Index

Exchange Rate

The price of one currency in terms of another is called an exchange rate. The convention is that the exchange rate is a price of domestic currency per unit of foreign currency.
For eg: Rs. 45.80 per dollar.

So if the exchange rate falls, the domestic currency is worth more.

The Big Max Index

Data for prices of the Big Mac Burger in local currency. Exchange rate of the local currency in terms of the local currency per dollar.

Implied PPP of the dollar, viz. it gives the actual purchasing power of the dollar in terms of that local currency.
Under-valuation or over-valuation of the currency. If the implied PPP is greater than the ER then we say that the local currency is overvalued. Otherwise we say that the local currency is overvalued. For eg: Chiles Peso is undervalued by 2.34%.

BigMac Price Country in Local Currency $2.54 Peso 2.50 A$3.00 Real3.60 1.99 C$2.99 Yuan9.90 Dkr24.75 2.57 HK$10.2 Forint 399 Rupiah14,700 Shekel 13.9 in US dollars $2.54 0.6868 1.6561 1.1502 3.1069 2.0974 1.1947 3.2715 2.5228 1.3792 1.6056 1.6473 2.9374

Actual Exchange Rate 1 USD = 1.00 3.64 1.8115 3.13 1.5613 1.5877 8.2868 7.5653 1.0187 7.7584 248.5 8923.8 4.732

Over(+) / Under(-) Valuation against the dollar, % -73.0769 -16.0916 -51.4377 21.7799 -17.4907 -52.9372 28.7457 -2.8173 -45.7362 -36.8209 -35.1509 15.5959

Purchasing Power Price

United States Argentina Australia Brazil Britain Canada China Denmark Euro area Hong Kong Hungary Indonesia Israel

0.98 1.52 1.52 1.28 1.31 3.90 9.74 0.99 4.21 157 5,787 5.47

Purchasing Power Parity (PPP): is a measure of the relative purchasing power of different currencies. It is measured by the price of the same goods in different countries, translated by the FX rate (or exchange rate) of that country's currency against a "base currency". How to read this table: In this case, the goods is the Big Mac. For example, if a BigMac costs 1.90 in Britain and costs $2.43 in US, then the PPP exchange rate would be 1.90/2.43 = 0.7819. If the actual exchange rate is lower (for example, 0.6349 for this case), then the BigMac theory says that you should expect the value of the British Pound to go up until it reaches the PPP exchange rate. The Over/Under valuation against the dollar is calculated as: (PPP - Exchange Rate) ---------------------------------- x 100 Exchange Rate

Key Indicators of Development

Population Gross national income (GNI) $ Billions 2004 $ Per Capita 2004 PPP Gross national Gross domestic product (Per capita % growth 2003-04

(Millions) 2004

$ Billions 2004

$ Per Capita 2004

China
India Switzerland USA Thailand Japan France Germany Brazil Russian

1,296.5
1,079.7 7.4 293.5 62.4 127.8 60.0 82.6 178.7 142.8

1,676.8
674.6 356.1 12,150.9 158.7 4,749.9 1,858.7 2,489.0 552.1 487.3

1,290
620 48,230 41,400 2,540 37,180 30,090 30,120 3,090 3,410

7,170
3,347 261 11,655 500 3,838 1,759 2,310 1,433 1,374

5,530
3,100 35,370 39,710 8,020 30,040 29,320 27,950 8,020 9,620

8.8
5.4 1.3 3.4 5.4 2.5 1.9 1.5 3.9 7.7

World Income (WDR 2005)

Population Gross national income (GNI) PPP Gross national Gross domestic product (Per capita % growth 2003-04

(Millions)

$ Billions 39,833.6

$ Per Capita 6,280

$ Billions 55,584

$ Per Capita 8,760

World

6,345.1

2.9

Low income

2,338.1

1,184.3

510

5,279

2,260

4.4

Middle income High income

3,006.2

6,594.2

2,190

19,483

6,480

6.0

1,000.8

32,064.0

32,040

31,000

30,970

2.8

The Regression Model

Consider model:

the

following

regression

Yi = 1 + 2Xi +ui

where, Y = actual exchange rate X = implied PPP of the dollar Regression

Purchasing Power Parity

PPP states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries.

Types of PPP

Absolute PPP: The statement that

exchange rates equal relative price levels is referred to absolute PPP. Relative PPP: Relative PPP states that the percentage change in the exchange rate between two currencies over any period equals the difference between the percentage change in the national price levels.

Calculation of PPP

To calculate PPP, one needs to price a representative basket of goods and services across countries.

Problems with PPP

Trade barriers and non-tradables Departure from free competition International differences in price level measurements PPP in the short run and the long run

Purpose of PPP

It is now primarily used to compare living standards across countries. From the perspective of exchange rate determination, PPP is useful as a reminder that monetary policy has no long-run impact on the real exchange rate. These rates are used to translate different currencies into a common currency to measure the purchasing power of per capita income in different countries. To facilitate international comparisons of prices and volumes for GDP and its components. Purchasing power parities as equilibrium exchange rates have long existed in international trade theory.

Big Mac Index:

Assumes that the big mac prices are constant and the dollar exchange rate will adjust to restore PPP Allows economists to make comparisons of exchange rates and relative prices of countries around the globe.

Problems With Big Mac Index

Big Mac is not a tradeable good Its prices vary across locations in a given country Local prices may be distorted by trade barriers on beef, sales taxes etc. Likely to prove to be an imperfect indicator of future exchange rate movements