What the price of a Big Mac says about currencies

Since 1986 The Economist has compared what a Big Mac costs around the world. The joke turns out to be a neat lesson in purchasing power parity, and in where it stops working.

In September 1986, Pam Woodall of The Economist had a half-serious idea: compare what a Big Mac costs in different countries. McDonald's sells it almost everywhere and makes it in much the same way, so it can stand in for a shopping basket. The paper has published its Big Mac index ever since, and the burger has found its way into economics textbooks.

Behind the joke is a real theory, purchasing power parity. It starts from the law of one price: if goods could cross borders freely and at no cost, the same thing would cost the same everywhere once you converted the money. Over time, then, exchange rates should drift towards the rate at which a basket of goods costs the same in every currency. The Swedish economist Gustav Cassel is often credited with developing the idea, in papers from 1916.

Official comparisons use enormous baskets. The OECD's includes more than 3,000 consumer goods and services. The Economist uses a basket of one.

Reading the burger

Take July 2023. A Big Mac cost 6.70 Swiss francs in Switzerland and 5.58 dollars in the United States. Dividing one by the other gives 1.20 francs per dollar: the exchange rate at which the burger would cost the same in both countries. The actual rate was 0.87 francs per dollar. By the burger's reckoning, the franc was overvalued against the dollar by about 38 percent, and a Swiss Big Mac cost 7.73 dollars.

The limits are just as instructive. You cannot ship a Big Mac across a border to profit from a price gap. Its price is mostly local: rent, wages, advertising, and what customers in that place will pay. Those costs are lower in poorer countries, where labour is cheaper, so burgers there tend to look cheap without the currency being wrong. In July 2023 the cheapest Big Macs in dollar terms included those in Taiwan, Indonesia and India.

The Economist allows for this with a second, GDP-adjusted version of the index, which takes account of how rich each country is. And market exchange rates move for many other reasons, from interest rates to speculation to central banks.

The index was never meant to forecast currencies. It was meant, in The Economist's own words, to make exchange-rate theory "a bit more digestible", and on that it has delivered.