Burgernomics – A Bite Sized Look At Currency Rates

If you like your economics in bite-size chunks, the new Big Mac currency index has been served up by The Economist magazine.

The index was started in 1986 as a humorous way of looking at foreign currency exchange rates.

Nearly two decades later, the index is included in economics text books and has triggered 20 or more academic papers.

The idea behind the index is if the prices of identical goods in different countries are compared, in theory the prices should eventually equalise.

The fact that they do not is a guide to the exchange value of a currency.

Comparing burger prices

The index is worked in four major comparison currencies – the US dollar, British pound, Chinese yuan and the euro.

According to the index, the price of a Big Mac in Britain is £2.89 – making that figure the base comparison for the rest of the world.

If a Big Mac costs more than £2.89 in another country, then that nation’s currency is overvalued against Sterling, while if the price is less, the currency is undervalued.

For example, a Big Mac costs £3.17 in the US, which according to the index, makes the US dollar 9.7% overvalued against Sterling and although the actual exchange rate is $1.51 to the pound, the implied rate is the dollar should be $1.66 to the pound.

However, in Indonesia a Big Mac is £1.48. This suggests that the Indonesian rupiah is 48.8% undervalued against the pound and the implied exchange rate is 9667 rupiah to a pound rather than the actual 18864 rupiah to the pound.

McDonald’s profits plunge

“Comparing the price of a Big Mac was never intended as an accurate measurement of currency misalignment,” said a spokesman for The Economist.

“It started as a fun way to make exchange rate theory easier to understand.

“The conclusion would normally be burger prices in poorer countries would be cheaper than those in richer ones because employees are paid less, but the index shows this is not generally so.”

Meanwhile, the latest profit figures from McDonald’s, the chain that sells the Big Mac, have plunged 15% while sales are down 7%.

Annual net income was down to $4.7 billion, making 2014 one of the worst years in the company’s history. Global sales fell to $6.5 billion compared to $7.1 billion in 2013.

Forecasts expected sales of $6.7 billion.

The company blames increasing competition from other chains biting into market share for the financial problems.

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