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Lecture Notes - Big Mac Index

The document summarizes the Economist's Big Mac Index, which uses the price of a Big Mac hamburger in different countries to estimate whether currencies are at their purchasing power parity (PPP) value relative to the U.S. dollar. It outlines the steps to calculate the PPP exchange rate implied by Big Mac prices in a foreign country compared to the U.S., and then determine if the foreign currency is over or undervalued based on the actual exchange rate. Examples are provided for the Czech koruna and Costa Rican colone to illustrate how to perform the calculations and interpret the results.

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Katherine Sauer
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231 views2 pages

Lecture Notes - Big Mac Index

The document summarizes the Economist's Big Mac Index, which uses the price of a Big Mac hamburger in different countries to estimate whether currencies are at their purchasing power parity (PPP) value relative to the U.S. dollar. It outlines the steps to calculate the PPP exchange rate implied by Big Mac prices in a foreign country compared to the U.S., and then determine if the foreign currency is over or undervalued based on the actual exchange rate. Examples are provided for the Czech koruna and Costa Rican colone to illustrate how to perform the calculations and interpret the results.

Uploaded by

Katherine Sauer
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Economics Dr.

Sauer

The Big Mac Index Fun with Exchange Rates: The Economists Big Mac Index

The index is a lighthearted attempt to gauge how far currencies are from their ________________ value. It is based on the theory of purchasing power parity (PPP). -says that in the _______________ exchange rates should move to equalize the price of an identical basket of goods between two countries Our basket consists of a single item, a Big Mac hamburger, produced in nearly 120 countries. The fair-value benchmark is the exchange rate that leaves burgers costing the _____________________ as elsewhere.

Example: The Czech Republic 1. To calculate the price in US$: Multiply the __________________ by the _________ exchange rate.

If you bought a Big Mac in the Czech Republic, it would cost you 67.6kr . Which means it really costs you __________________. - It is _________ expensive to buy a Big Mac in the US than in the Czech Republic.

2. To calculate the implied PPP of the US$: Divide the ______________________ in the foreign country by the ____________________ in the US.

3. ________________________ the PPP rate to the actual exchange rate to see if the currency is over or undervalued versus the US$. To calculate how much the koruna is under or overvalued by: (PPPrate actual exchange rate) / actual exchange rate x 100

Because the koruna is __________valued vs the dollar, we expect the koruna to _________________ vs the dollar in the future. ____________________________________________________________________________________ Example: Costa Rica 1. Calculate the price in US$:

-It is _____________ expensive to buy a Big Mac in the US than Costa Rica.

2. Calculate the implied PPP of the US$:

3. Check to see if the currency is over or undervalued versus the US$.

Because the colone is _______valued vs the dollar, we expect the colone to ________________ vs the dollar in the future.

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