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Exchange rates and the ‘Big Mac’ Index

Tom White

23rd January 2014

This is a great learning aid, especially if you've not come across it before. If you're trying to understand exchange rates, you often end up wondering which countries have overvalued exchange rates (that should, ideally, depreciate in value) or those that are undervalued (where appreciation would probably help).The idea is so simple - find a product that's available in most countries, produced to a standardised design, and that serves as a reasonable 'basket of goods' capturing a range of price data for the economy you're looking at. By this measure, the countries with expensive Big Macs have overvalued exchange rates and cheap Big Macs means an undervalued exchange rate.

The Economist have been producing their index for several years, and what started out as a light-hearted exercise has turned into something that is taken seriously - so seriously that you can legitimately talk about the Big Mac index in your exams (with supporting explanation, of course).

The key concept under discussion is really PPP (Purchasing Power Parity, or what is the real buying power of a local currency).

This topic is hugely relevant to Economics students, and it's very current. No matter how you measure it - Big Macs or otherwise - the £UK has steeply depreciated in recent years. That should have boosted our exports .... only it doesn't seem to have done so, and the UK's export performance is struggling.

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