Obviously, it is rather hard to imagine international trade in Big Macs, but if hamburgers are a good indicator of general price levels, they might still tell us which currencies are overvalued, and therefore likely to fall. If the prices are different, then trade will take place to even them out.
Big mac index us prices fall mac#
At the current 1.88 exchange rate, the Big Mac in London is 18% more expensive than in the US, so sterling is 18% overvalued against the dollar.Īctually, this is a simple version of the purchasing power parity theory of exchange rates, which says that currencies will adjust so that the prices of various goods in different currencies will be the same, when expressed in the same currency (such as dollars). This implies that on the Big Mac standard, the "fair value" of the $/£ exchange rate is 1.60 - the rate that makes the Big Mac cost the same in the UK as in the US. But if the $/£ exchange rate were only 1.60, then the Big Mac in London would cost only the equivalent of $3.10, exactly the same as it costs in America. So he might say to himself: things are pretty expensive in the UK, compared with back home.
At the present $/£ exchange rate of 1.88, that implies that an American in London would think that his Big Mac over here costs rather a lot at $3.65. For such a simple, even quirky, concept, it has provided endless fascination to academic economists and currency traders alike.Ī Big Mac currently costs $3.10 in the US, and £1.94 in the UK. This is not, as you might think, an index of the number of hamburgers sold by McDonald's, but an approach to the valuation and forecasting of exchange rates.
H appy birthday to the Big Mac Index, which was invented by Pam Woodall of the Economist exactly 20 years ago this week.
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