Economist magazine published a popular thought-provoking article on big Mac index or purchasing power parity. It formulated a few parameters for the measurement of the purchasing power in different nations intending to make the transactions affordable. The difference between two foreign currencies influences the product selling prices. The dollar amount in the US market is varied compared to the pound in the UK. MacDonald has set a new guideline to fix the price of the basket of the products in multiple nations. Exchange rates should be equal in other nations without increasing the prices of products. There are many advantages of introducing big mac index theory. Get a roadmap and basic ideas of how the Big Mac Index works by checking the site of Thebizzing.
Advantages of Using Big Mac Index
The big mac index theory equalizes the price of products in one country to the basket of products sold in another country. It will boost up the local buyers in a third world country to save money while buying the same products from the vendors. A basket of the burger is costly in the US but it will be expensive as well for an economical person living in Somalia. Through the proper calculation of big mac index, product prices will be more or less equal. For example, the value of the Canadian dollar is 1.3 against 1 dollar in the US. To buy the US dollar with the Canadian currency, you need to spend 1.30. So, the exchange rate should align the two currencies so that there will be minimal difference to buy the product in other nation. It will be beneficial to buyers who want the money saving.
How to Calculate Big Mac Index?
Big mac index formula wipes out misalignment between two currencies. It is appropriate for controlling the prices of products for sale. It will benefit common buyers who are willing to purchase products at reasonable prices. Divide the price of the product in one country by the price of basket of products in the US. The result is the current exchange rate. Now compare it with the standard foreign exchange rate to calculate the parity of purchasing power. It will be clear whether your currency is undervalued or over-valued. For example, a Big Mac product costs you three pounds when you stay in Britain. Similarly, the same product is sold for 5 dollars in the US. If you sum up by dividing the local currency in Britain by the product price in the US, you will get the exchange rate which must be compared to the current exchange rate. If the exchange rate is low, the first currency is undervalued (i.e. 3 pound in the UK). If it exceeds the actual exchange rate, it will be overvalued.
What Is the Importance of Big Mac Index?
Big Mac Index is useful to overseas traders who have to export and import products using different currencies. They make their budgets based on the product prices in various countries. They need to check whether a particular product will be cost-effective for them when they will go to that country. They need the proper balance in product prices. They can avoid those high-risk zones where the price of the Mac basket is much higher. Well, sometimes, the big Mac index is not workable as there are other factors to impact the product prices. The geographical locations, labor cost, and availability of the transportation systems to deliver the consignments increase the manufacturing cost of the products.
Big Mac Index is believed to be the fixed standard tool for gauging price differences. A trader can utilize this universal price comparison theory to buy the products at low rates and sell it at higher prices in another country. Though the value of the foreign currencies goes up and down, the Big Mac index will not change dramatically. It helps global traders to exchange or supply products to different countries without paying extra dollars due to the fluctuation in the currency prices. It is an international informal measurement of prices of the products in multiple nations.
As per the survey reports in 2021, McDonald has opened its outlets in 118 countries. So, this magnificent theory is accessible to these countries. People like to purchase their products based on Big Mac Index. Proper PPP inhibits the anomaly in the product prices assisting people to buy the specific products at the same rates. Finally, in case you take the big mac index formula to estimate the prices of products, it will give you an idea about the currency undervaluation or over-valuation of the American dollars. Big Mac Index works fantastically in those countries where the government does not declare any price comparison reports. Traders like to opt for the big mac index theory to do the proper measurement of currency undervaluation against the American dollars.
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