1. Under what conditions might an index based on the pricing of Big Mac sandwiches be most useful in understanding whether a particular currency is overvalued or undervalued? When might such an index perform poorly? 

2. UBS Wealth Management Research has used the Big Mac index as a basis for assessing the purchasing power of an average worker in a particular country. In this regard, they identify the amount of time an average worker in a nation would have to work in order to earn enough money to buy a Big Mac. How might information such as this be of value to business people?

The Economist magazine presents an interesting application of PPP theory through its “Big Mac Index,” which substitutes a Big Mac for the basket of goods economists have traditionally used. The index calculates the exchange rate at which a Big Mac in other countries costs what it does in the United States. The index collects data on the current price of Big Mac sandwiches at McDonald’s restaurants around the world. Comparing these prices based on current exchange rates with the PPP-based price of a Big Mac provides an indication of whether a particular currency is overvalued or undervalued. The figure in this box shows the overvaluation and undervaluation of national currencies using the implied exchange rate, based on the market price of the Big Mac.

The Economist claims that its Big Mac index performs pretty well over the long run. Of course, when using this index, we must remember that the price of a Big Mac represents more than a basket of tradable goods, the situation PPP theory describes. For example, the service we receive with our Big Mac cannot be traded, nor can McDonald’s brand image. Despite this, the index is a helpful way to obtain a quick sense of relative currency values and where they may be heading. The latest Big Mac index and actual prices can be found at http://www.economist.com/content/big-mac-index/.