# What do the prices of a BigMac Hamburger around the world tell us about exchange rates?

According to the theory of Absolute Purchasing Power Parity (PPP) , the prices of the same basket of goods in two different countries when expressed in the same currency should equalize. BigMac hamburgers are almost identical around the world because of MacDonald's quality control and may be used as a such basket. Let e denote the exchange rate of country X's currency per US dollar. We must have

Price of BigMac in US * e = Price of BigMac in country X.

Hence, the exchange rate implied by PPP is

e = Price of BigMac in country X / price of BigMac in US.

A country X's currency is said to be overvaluation(+) or undervaluation(-) by y%, where

valuation y = (exchange rate implied by ppp - actual rate) / actual rate x 100 %
Country X's currency is said to be overvalued if the implied exchange rate is greater than the market exchange rate (country X's currency per US dollar); and PPP says country X's exchange rate should devalue (or depreciate). And vice versa.

From the Economist 2000 issue, we know that

the price of a BigMac in the Unitied States was 2.5100 US dollars,
the price of a BigMac in Hong Kong was 10.2000 Hong Kong dollars.

The theory of Purchasing Power Parity implies an exchange rate of 10.2000/ 2.5100 = 4.06 Hong Kong dollars per US dollar. The exchange rate of HK dollar against US dollar was 7.7900 around 2000.

Thus PPP says HK dollars is undervaluated by 48%.

In the following table, you may give another Big Mac price into the domestic price column and then click the button "Calc me" to calculate the new implied PPP. As you can see, the price of Big Mac and the implied PPP are positively related.

 Country Domestic Price Exchange rate Implied PPP Valuation(-/+) Action United States USD % Argentina ARS % Australia AUD % Brazil BRL % Britain GBP % Canada CAD % Chile CLP % China CNY % Czech Republic CZK % Denmark DKK % France FRF % Germany DEM % Hong Kong HKD % Hungry HUF % Indonesia IDR % Israel ILS % Italy ITL % Japan JPY % Malaysia MYR % Mexico MXP % New Zealand NZD % Poland PLZ % Russia RUR % Singapore SGD % South Africa ZAR % South Korea KRW % Spain ESP % Sweden SEK % Switzerland CHF % Taiwan TWD % Thailand THB %

The exposition of Purchasing Power Parity may be found in standard International Economics or International Finance textbooks, e.g., Krugman and Obstfeld (1997). Data of BigMac prices around the world is from various issues (usually in April, starting from 1986) of The Economist. These issues of the Economist also discuss the behavior of PPP implied exchange rates and its comparison with the actual exchange rate.

REFERENCES:

Cumby, Robert (1996): "Forecasting Exchange Rates and Relative Prices With the Hamburger Standard: Is What You Want What You Get With McParity?" National Bureau of Economic Research Paper: 5675, July 1996, pages 13.

Ong, Li-Lian (1997): "Burgernomics: The Economics of the Big Mac Standard," Journal of International Money and Finance; 16(6), December 1997, pages 865.

Click, Reid W. (1996) "Contrarian MacParity," Economics Letters; 53(2), November 1996, pages 209-12.

Pakko, Michael; Pollard, Patricia S. (1996) "For Here or To Go? Purchasing Power Parity and the Big Mac," Federal Reserve Bank of St. Louis Review; 78(1), Jan.-Feb. 1996, pages 3-2.

Krugman, Paul R.; Obstfeld, Maurice "International Economics : Theory and Policy," Fourth Edition Addison Wesley.

© 2000 The Chinese University of Hong Kong