Ppi and the Big Mac Index
Estimating the Purchasing Power Parity (PPP) of currencies using the Big Mac Index™
Table of Contents
1. Introduction
2. Purchasing Power Parity and Theory of one Price
3. Over/Under Valuation of currencies against the Dollar
5. Comparative analysis of the most overvalued to the most undervalued
6. Observation and Alternative indexes
7. Limitations
8. Appendix
INTRODUCTION
Purchasing power parity (PPP) is an important and critical topic in international economics. It arises when the purchasing power of an amount of money is the same in different countries. This is when prices of two different countries are converted to a common currency. The idea is based on the law of one price, where in the absence of official trade restrictions, similar goods will have the same price in different markets, with the prices being expressed in the same (common) currency.
Deviations from parity infer differences in purchasing power of goods across countries, which means that for the purposes of many international comparisons, countries' GDPs or other national income statistics need to be "PPP adjusted" and converted into common units. There can be a huge difference when adjusted by purchasing power and when converted via market exchange rates. For ex:- If calculated at nominal exchange rates, India has the tenth largest economy while adjusting by PPP, India has the fourth largest economy. Thus, to remove this discrepancy, a common currency of measurement is highly essential.
The Big Mac Index is an example of a measure of law of one price. It refers to the prices of a Big Mac burger in McDonald's restaurants in different countries. It helps in determining whether a currency is undervalued or overvalued and thus accordingly gives an idea about the direction in which currencies should move. The Big Mac was selected because it is available for a common purpose in many countries around the world as local McDonald's franchisees have significant responsibility for
Table of Contents
1. Introduction
2. Purchasing Power Parity and Theory of one Price
3. Over/Under Valuation of currencies against the Dollar
5. Comparative analysis of the most overvalued to the most undervalued
6. Observation and Alternative indexes
7. Limitations
8. Appendix
INTRODUCTION
Purchasing power parity (PPP) is an important and critical topic in international economics. It arises when the purchasing power of an amount of money is the same in different countries. This is when prices of two different countries are converted to a common currency. The idea is based on the law of one price, where in the absence of official trade restrictions, similar goods will have the same price in different markets, with the prices being expressed in the same (common) currency.
Deviations from parity infer differences in purchasing power of goods across countries, which means that for the purposes of many international comparisons, countries' GDPs or other national income statistics need to be "PPP adjusted" and converted into common units. There can be a huge difference when adjusted by purchasing power and when converted via market exchange rates. For ex:- If calculated at nominal exchange rates, India has the tenth largest economy while adjusting by PPP, India has the fourth largest economy. Thus, to remove this discrepancy, a common currency of measurement is highly essential.
The Big Mac Index is an example of a measure of law of one price. It refers to the prices of a Big Mac burger in McDonald's restaurants in different countries. It helps in determining whether a currency is undervalued or overvalued and thus accordingly gives an idea about the direction in which currencies should move. The Big Mac was selected because it is available for a common purpose in many countries around the world as local McDonald's franchisees have significant responsibility for