Big Mac Index (our first Economics thread!)

[Buffy]

Okay, here's our first economics thread: What's the validity of The Economist's "Big Mac Index"

Quick intro: Relative economic value in different countries is hard to measure. The reason that the dollar is worth 1.3 euros is mostly based on analysts feeding information to currency traders based on looking at "typical baskets of goods" that could be obtained in different locations in the local currency (the "goods" typically also include cost of labor if you're wondering). This is what's used to figure out "rich economies" from poor ones as well. Now these "baskets" are pretty arbitrary. Everyone has a different one, and in some "controlled economies" (e.g. China), the numbers are heavily manipulated by the government. Thus, the only thing that you can really analyze is what pops out of currency trading markets, and most economists agree that while heavily arbitraged (markets of independent traders tend to fully assimilate and average out all available information), these numbers have enormous anomalies, and result in countries like China showing much larger growth rates that they probably actually have.

Several years ago, The Economist magazine, half in jest came out with a "Big Mac Index" (see http://www.economist.com/markets/bigmac/ for the full background and the most recent indexes). The basic idea was that Big Macs are the same everywhere, involve a basket of goods (beef, lettuce, sesame seeds, paper, various kinds of labor, etc), and are traded widely enough to incorporate all sorts of variations that can bias "basket of goods" approaches.

This joke turned out to be much more, as various people investigated it, correllated it to other data, and found that, sure 'nuff, this thing actually works! So the Economist regularly updates it.

Now lots of people have complained about this as not being comprehensive (You will not find too many McDonalds in Mali or Laos), and it only reflects a specific band of service labor that completely misses strong high-end service economies (the US and Western Europe) and low-end service economies (China, Malaysia, Indonesia for example which now produce most of the world's textiles).

Two possible tangents for discussion:

1) What else is wrong with this index?
2) Can you think of any other popular items that might be worthy of an index?

Cheers,
Buffy

[Tormod]

The most obvious point of failure is of course that it is an index based on western (mostly American) goods. Apart from that I see it mostly as just another way for American economists to show how important control of the global economy is.

I also wonder why they include Sweden and Denmark but now Norway. *chuffs*. Big Macs cost half a fortune over here.

[alxfamlaw]

I have heard of the BIG MAC theory of Indez in the legal field because calculations on attorney wages is equal to new attorneys charging what a big mac cost but on an hourly basis. Now, there is nothing wrong with the index in that works in and around 120 countries. The theory goes that in the long run dollar here should be about the same anywhere else. Now, what you did not factor in was the PPP (purchasing-power parity), which compares currency’s actual exchange rate with its PPP to see if the currency is undervalued or overvalued. Now the problem with the BIG MAC test is that it is difficult to valuate against the EURO. It is betterto gamble on the most undervalued of the main currency, which is a profitable strategy.

[Buffy]

Originally Posted by alxfamlaw

The theory goes that in the long run dollar here should be about the same anywhere else. Now, what you did not factor in was the PPP (purchasing-power parity), which compares currency’s actual exchange rate with its PPP to see if the currency is undervalued or overvalued. Now the problem with the BIG MAC test is that it is difficult to valuate against the EURO. It is betterto gamble on the most undervalued of the main currency, which is a profitable strategy.

Actually, The Economist argues that the index is a measure of PPP, then they use the numbers that pop out as a comparison of exchange rates and determines whether the currencies are over or undervalued based on that. If (to simplify the math with bogus numbers) a Big Mac costs $1.30 in the US and 1.00 Euros in Europe, and the exchange rate is $1.25 to the Euro, the Euro is undervalued. The question is whether the currency traders have incorporated information that the price of a Big Mac does not that makes the over/under valuation valid.

Cheers,
Buffy

[Pyrotex]

Originally Posted by Buffy

Actually, The Economist argues that the index is a measure of PPP, then they use the numbers that pop out as a comparison of exchange rates and determines whether the currencies are over or undervalued based on that....

... ... ...

uh, I ate a Big Mac once.

[Buffy]

Originally Posted by Pyrotex

uh, I ate a Big Mac once.

And you contributed to the economic power of our marvelous monetary system!

The index has been going up lately, showing that the dollar is becoming stronger and this is one of the many reasons that the price of oil--which is denominated in dollars on most markets--is going down....

YouTube - 1980's McDonalds Hamburger University...

You deserve a break today,
Buffy