The Big Mac Index is the Economist magazine’s fun little twist on what economists call Purchasing Power Parity. Purchasing Power Parity is the idea that a particular amount of any currency should buy the same amount of “stuff” in every country and that, should it not, the currency should regress back to the mean of being able to buy that same amount of stuff. In this little analogy of Big Macs, the MacDonald’s Big Mac is the “stuff” and a dollar’s worth of Big Mac should be equal to a dollar’s worth, in another currency, of Big Mac, in that other country. When it isn’t, then you have an overvaluation or undervaluation of currency. It really helps people understand the otherwise complex topic within exchange rate theory.

Well, it’s not the only one, though it’s certainly the most well-known since it was the first and because MacDonald’s is so ubiquitous. There’s the popular Starbucks latte test, the Coca-Cola index, the sushi index, and my favorite one of them all, the Steakhouse index. Mmm… steak.

(Photo: jimmy_macdonald)

From department of fun economics: The Economist puts out their Big Mac Index every few months, which they claim is “the world’s most accurate financial indicator to be based on a fast-food item.” The Big Mac Index is a measurement of a currency’s purchasing power based on the price of a Big Mac in that country. The idea is that since a Big Mac is the same in every country (obviously not the case, but close enough) then you should be able to derive an exchange rate, compare it to the actual exchange rate, and figure out if a currency is over or undervalued.

Here’s the latest Big Mac index from June 5th, 2005.