Business, Finance & Economics

Purchasing Power and the Big Mac Index

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Big Mac

Economists study something called purchasing power parity. Basically, how far will a dollar go in Argentina, Italy, or the US? They gauge this by looking at a comparable basket of goods and services across nations.

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The trick is to find the right basket.

"You want something that is comparable, especially if you want to look at price inflation rates across countries," said Matthew Slaughter, associate dean at Dartmouth's Tuck School of Business. "And one of the great things about the Big Mac is, to their credit, McDonald's makes the same Big Mac whether it's in Buenos Aires or Boston."

The Big Mac Index was first introduced by The Economist magazine in 1986. It began as something of a joke. But the price index quickly caught on as good way to measure purchasing power across borders.

With the Big Mac, you've got a whole basket of goods and services right between the sesame seed buns. There's lettuce, tomatoes, and meat. There's also the cost of marketing and the electricity needed to light up the golden arches, all factored into the price of the burger. And that's why you look at the whole Big Mac, said Slaughter.

"If you take just an ingredient out of a Big Mac, like a head of lettuce, there's a lot of local variation in the type of lettuce that there is in Argentina and the United States and other countries, that make it a lot harder to be confident you're actually measuring the same product across those locations."

But if the Argentine government is indeed artificially suppressing the price of its Big Macs to game the index, Slaughter said there are plenty of alternate measures.

"You could go across the street to Burger King and price Whoppers, you can go to Wendy's and price a particular Wendy's sandwich. The key is, especially if looking across countries, is trying to have an identical product, which is why something made by a global corporation is often times useful because they have the same standards, whether it's IKEA, or McDonald's, or Burger King."

But just how much weight should we give to the Big Mac Index? Or a Whopper or IKEA Index?

Robert Paarlberg teaches his political science students about the Big Mac Index at Wellesley College. He likes the index and says it's a good way to understand the concept of purchasing power. But…

"I don't think it's a very good indicator of anything. But it's great fun for everyone.

Outside of the classroom, economists and policymakers look at a much bigger picture to gauge inflation or purchasing power. Paarlberg said just looking at one product, like a Big Mac, is an overly simplistic way to really understand economic conditions.

"In the United States, when we measure inflation, we use a basket of goods, not any one good. And when we construct the consumer price index, we actually take care to exclude food and energy because the prices of those goods are so volatile, they would create a volatile index that would drive business decisions in the wrong direction."

So, take the real-world usefulness of the price of a Big Mac with a grain of salt, or to be more accurate, 2.1 grams of salt.