What is the Big Mac PPP?

The Big Mac PPP (purchasing power parity) or Big Mac Index compares the prices of a Big Mac burger sold by McDonald's (MCD) all over the world. Its aim is to evaluate affordability of the burger in the local currency, and therefore determine whether the currency is under-or overvalued.

This is based on the premises of purchasing power parity (PPP), which states that identical goods should have a stable value across the currencies it is sold in globally.

The macroeconomic theory of purchasing power parity is used to judge the economic standard of living existing in different countries of the world by equating the currencies used in these regions.

History of Big Mac PPP

The origins of Big Mac PPP dates back to 1986, when a Big Mac Index was first published in The Economist.

In a semi-humorous illustration by Pam Woodall, the index was printed to gauge purchasing powers between different currencies of the world. This gave way to the coined term Burgernomics, which reflects an informal way to evaluate the purchasing power parity between currencies.

How to calculate the Big Mac PPP?

In order to conduct a Big Mac PPP calculation, the price of Big Mac in country A (in A’s local currency) should be divided by the price of Big Mac in country B (in B’s local currency).

This ‘Big Mac Exchange Rate’ between the two countries should be then compared to the actual exchange rate to gauge which currency is overvalued or undervalued with respect to the other.

Example of Big Mac PPP

To illustrate the concept of Big Mac PPP, let’s look at the example of the US dollar against the British Pound. According to January 2022 data, a Big Mac costs £3.59 in the UK and $5.81 in the US.

As per purchasing power parity, the exchange rate should be $1 for £0.62. However, as per the actual exchange rate of £0.75, as of 31 March 2022, it seems that the British pound is 17.1% undervalued against the US Dollar.

Why was the Big Mac chosen?

In an attempt to make the exchange-rate theory a bit more digestible and reach the masses, the Big Mac was chosen due to the popularity of the McDonald's franchise.

With roughly over 38,000 outlets globally and prominence in 120 countries, McDonald's has a defining characteristic of consistency in their core menu offerings, which is why it seemed like a fitting product to test currency discrepancies.

Limitations of Big Mac PPP

While the Big Mac PPP does give some insights into the real purchasing powers existing between different currencies, it cannot be relied upon as a definitive comparison tool due to the following reasons:

The pricing of a Big Mac will depend upon the local logistics standards. The cost of producing, distributing and advertising the product would take cues from the local markets, which tends to vary between different countries.
Culturally, the acceptance of burgers or fast food as part of a regular diet isn’t linear across the globe. In some countries, the demand for a Big Mac would always outweigh others, leading to price differences and relative ratios.