Purchasing Power Parity is based on the concept of the “law of one price” which states that the same goods should cost the same in different countries when you factor in the current exchange rate. This simply means that a dollar should buy the same product in every country.
If you find this concept a bit hard to consume, you will probably need the Big Mac Index.
The Economist annually publishes the Big Mac index which tracks the price of Big Macs in more than 120 countries. So, what do we learn from this index? The index uses the US dollar as a benchmark and analyzes whether other currencies are over/undervalued relative to the US dollar. Big Macs cost $3.57 in the US. According to purchasing power parity, any variation in the price of a Big Mac from $3.57 indicates that the country’s currency is either over/undervalyed. Studying the table below, a Big Mac cost less in Asia and more in Europe. This means that Chinese Yuan is undervalued and the Swiss Franc is overvalued relative to the US dollar.
It also means that you should eat a lot of Big Macs in South Africa if you ever make it to the World Cup!
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Loading ...Tags: Big Mac Index, Exchange Rate, Law of One Price, PPP, Purchasing Power Parity
I wonder how much the big mac costs in Kuwait?
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The BigMac in Kuwait costs 0.850 fils which translates into $2.97. Given the theory above the KWD should appreciate 16% relative to the USD.
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[...] in other words purchasing power parity. A couple of weeks ago I posted about a similar subject “Burgernomics” where different Big Mac prices in different countries value the home currency relative to the [...]