Ques.: The Economist publishes every year the prices of a standard BigMac around the world. Find the BigMac prices for the USA, France, and South Korea and the corresponding (average annual) nominal exchange rates in 2006 and 2009. Calculate for each of these countries the implied PPP of the dollar 2006 and 2009 and compare this to the actual exchange rates. Can you explain the differences in implied PPP of the dollar and the nominal exchange rates?

The Economist’s Big Mac index is an informal index sometimes used to judge whether current exchange rates between different currencies are justified and currencies are at their correct exchange rate, though it is not intended to be a precise predictor of currency movements. Now commonly known as burgernomics, it is based on the theory of Purchasing Power Parity (PPP). PPP is the notion that a dollar should buy the same amount of goods in all countries. It suggests that a long term equilibrium will adjust exchange rates such that the purchasing power or cost of traded goods and services in different countries will be the same. It is based on thelaw of one price: in ideally efficient markets, identical goods should have only one price.

The Big Mac index uses the prices of McDonald’s Big Mac hamburger, which is produced in about 120 countries. It assumes that the Big Mac is a similar product in each economy, wherever produced, and it is made with identical specification, thus it should have the same price everywhere.

The following tables compare the Big Mac prices, nominal exchange rates and the Implied PPP for USA, France and South Korea for the year 2006 and 2009.