The Big Mac index

The purchasing power parity is a theory that has been used greatly used to determine the purchasing power of people living in a particular country as compared to another. Here, theorists suggest that when currencies exchange rate is in equilibrium the purchasing power between the countries is equal. However, this concept is considered more formal and to make it more understandable, The Economist developed The Big Mac index. This concept tries to find out if currencies of different countries correctly determine the purchasing power of the countries residents. Here, the economist’s uses Big Mac prices of different countries to determine which currency is overvalued and which one is undervalued. In their concept,the economists argue that countries that have the same purchasing power have equal prices of Big Mac. However, if there exists a variance between the prices of Big Mac in two countries, it is a manifestation of purchasing power disparity between the countries.

Although initially the Big Mac pricing index was used to determine the price of burgers across countries, it has become a widely accepted index for informal determination of currency exchange rates and pricing strategies. The big mac index goeshand in hand with the adjusted index, which addressesthe assumption that poor countries have cheaper burgers due to reduced production costs. Here, the economists find that PPP has a deficiency since it only talks about the long run effect, but shy off addressing on the current equilibrium rate. According to the article, the current fair value of the currencywould be best be determined by examining the relationship between GDP and prices. The currency over and undervaluationis then determined using the line of best fit, which is derived from an adjustedindex of GDP and prices of the selected countries.

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