Big Mac Index, Essay Example

The Big Mac Index (BMI) was invented by The Economist publication in 1986 to determine whether currencies around the world are appropriately valued. In other words, BMI helps us get an idea of the currencies that are appropriately valued, overvalued, or undervalued. The index is based on the economic concept of purchasing power parity which theorizes that exchange rates in the long run become such that a basket of certain goods and service costs the same everywhere. The BMI looks at the price of a Big Mac burger in every country to determine whether the currency is accurately valued. Though the price of a burger is an a reliable indicator of the appropriateness of currency value, it does make it easier to understand the concept of exchange rate theory(The Economist, 2014).

It is important to note that the prices indicated by the BMI are not the actual prices one pays for Big Mac burger in a particular country. Instead, the index takes into account the relationship between the price of a burger and the GDP per capita in a country. As far as BMI index is concerned, it is most expensive to buy a Big Mac in Norway and it is least expensive to buy a Big Mac in India(The Economist, 2014).

There are also other factors besides currency overvaluation and undervaluation that may explain the difference in the prices of Big Macs around the world. One factor may be income levels. Countries where income levels are high may be more likely to have Big Macs being sold at higher prices because prices go up as more and more income chases a particular good or service(Boyes & Melvin, 2012). Big Macs may also be more expensive in certain countries due to higher labor costs. Labor costs have a significant impact on the overall production costs and as a result, are reflected in the price of a particular good or service. The targeted market segment may also determine whether Big Mac is expensive or cheap. Big Mac may be a luxury product in certain countries and the targeted market segment may be middle class rather than everyone. As a result, Big Mac price will be higher than it would have been were it being targeted at everyone.The price of inputs such as meat and buns may also determine whether a Big Mac is more or less expensive in a particular country because input prices are part of the overall production costs. The prices of Big Mac around the world may also be influenced by the level of demand. When demand is high, the producer is able to offer lower prices due to being able to take advantage of economies of scale. But if the demand level is low, the producer has to charge higher prices in order to cover the costs as well as earn a certain profit margin.

Based on the theory of purchasing power parity, many developing countries such as India, China, and Indonesia may see their currencies appreciate against the U.S. Dollar. On the other hands, countries like Norway, Sweden, and Switzerland have overvalued countries and may witness their currencies depreciate against the U.S. Dollar.In other words, most of the developing countries may be faced with rising currency values while the opposite is more likely to be true for developed countries including the U.S.

References

Boyes, W., & Melvin, M. (2012). Economics (9th ed.). Cengage Learning. Print.

The Economist. (2014, January 23). The Big Mac index. Retrieved May 19, 2014. Web.