Big Mac Index
Sample Solution
The Big Mac is a good product to find PPP because it is a standardized product that is available in over 100 countries around the world. This means that it is possible to compare the price of a Big Mac in different countries to get a sense of the relative purchasing power of their currencies.
The Big Mac is also a good product to find PPP because it is a basket of goods. This means that it includes a variety of different goods, such as beef, bread, cheese, and lettuce. This makes it a more representative measure of purchasing power than a single good, such as the price of a gallon of milk.
Full Answer Section
Why the exchange rate is not always in PPP
The exchange rate is not always in PPP because of a number of factors, including:
- Transportation costs: The cost of transporting goods between countries can vary significantly. This can lead to differences in the price of goods between countries, even if the goods themselves are the same.
- Tariffs and other trade barriers: Governments often impose tariffs and other trade barriers on goods that are imported from other countries. This can also lead to differences in the price of goods between countries.
- Different levels of economic development: Countries with different levels of economic development may have different levels of prices. For example, prices in developed countries are generally higher than prices in developing countries.
- Market imperfections: Market imperfections, such as monopolies and oligopolies, can also lead to differences in the price of goods between countries.
Example
The following example illustrates why the exchange rate is not always in PPP:
- The price of a Big Mac in the United States is $5.50.
- The price of a Big Mac in China is 25 yuan.
- The exchange rate between the US dollar and the Chinese yuan is 7 yuan per US dollar.
Based on the exchange rate, a Big Mac in the United States should cost 38.5 yuan. However, the actual price of a Big Mac in China is 25 yuan. This suggests that the Chinese yuan is undervalued relative to the US dollar.
Conclusion
The Big Mac Index is a useful tool for understanding the relative purchasing power of different currencies. However, it is important to remember that the exchange rate is not always in PPP. There are a number of factors that can cause the exchange rate to deviate from PPP.