# The Big Mac Index: Implications for Microfinance

Feb 16, 2007 by

Every year, The Economist publishes The Big Mac Index, which I have included below:

(Click the link above to see a larger version of this chart. Unfortunately, I cannot display a wider image in this blog.)

To create this index, The Economist examined both the local price of a McDonald’s Big Mac hamburger and the exchange rate between the local currency and U.S. Dollars. The first column contains the local price of a Big Mac, and the second column contains that price, converted using the exchange rate, into U.S. Dollars. As you can see, although a Big Mac costs approximately \$3.22 in the United States, its price is far different in other countries. With \$322, an American could buy 100 Big Macs within the United States. However, if he traveled to Argentina, where Big Macs cost \$2.65 after their price in Argentinian Pesos has been exchanged to U.S. Dollars, he could buy \$322 / \$2.65 = 121.5 Big Macs. Thus, an American tourist could buy 21.5% more Big Macs in Argentina than at home. What does this mean? The Argentinian Peso is undervalued 18% against the U.S. Dollar.

1 – (\$2.65 / \$3.22) = -.18

So, Argentinian goods are effectively cheaper for Americans to buy than domestic goods, after adjusting for the exchange rate. Unfortunately, the deal is far less good for an Argentinian. If an Argentinian tourist brought his pesos to the U.S. and converted them, he would find that money which once bought 100 Big Macs now only bought 82. As a result of this difference in Purchasing Power Parity, Americans can afford to import goods from Argentina, but Argentinians struggle to afford comparable American goods. From the table, you can see that China is 56% undervalued against the U.S. Dollar, while Iceland is 131% overvalued against the U.S. Dollar. As a result, we tend to import things from China and export things to Iceland.

What does this mean for microfinance? If Americans wish to buy the labor of people in other countries, due to differences in Purchasing Power Parity, it is possible for them to do so at a different cost than would be possible in the United States. As many of you know, I sometimes compensate people for their participation in this blog. Often, the size of the compensation is around three cents. When people residing in China receive my three cents, they receive far more value when Americans receive my three cents, due to differences in Purchasing Power Parity. \$0.03/(1-.56) = \$0.068. Thus, according to the Big Mac Index, a three cent reward could provide almost seven cents of goods if spent in China. The rewards that I provide through this blog may be far more appealing in other countries! Imperically, I have observed this, as many of the people I have compensated have contributed from abroad.

When you hear in the news about people willing to work for “low wages,” in some cases, those people can buy the same amount of goods with their reduced wages as an equivalent person in the United States. If the Big Mac Index is representative, a Chinese worker paid \$44,000 per year could buy the same basket of goods (in China) as an American worker paid \$100,000 could buy in America. (Needless to say, when people are receiving less than their Purchasing Power Parity equivalent salary, they are in fact working for lower wages, and thus only able to afford a lower standard of living.)

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1. Sarah

This entry raises an interesting question: In the presence of continued globilization, will the price of labor eventually respond to the supply/demand that you’ve described to become more consistent across multiple markets? If so, it would seem likely that the difference in value of various currencies would also respond. However, any discussion of this idea must also consider the effect of regulation in different regions, making it too complex to describe using any particular macroeconomic theory based on the US economy.

2. Jason

An interesting thing to take account of in this situation is the pinning of the Chinese currency to the American dollar. The Chinese keep their currency perpetually undervalued to allow cheap exportation to the huge American market.

What is interesting however is that other countries local to China also have an undervalued currency, according to this extremely narrow metric anyway, and so have the ability to cheaply export good to America. It also makes tourism there quite financially attractive to Americans, as compared to the now expensive European climate.

3. Daniel

This macroeconomic disparity can be experienced in relatiion to movement of labour in Europe. Especially in close proximity to national borders. An example is the cities of Vienna, Austria and Bratislava, Slovakia. The cities are 30 miles apart but the wages are 4 to 5 times better in Vienna. Any observer at a Vienna railway station in a morning will see hundreds of “day commuters” arrive to the city from the border zones of neighbouring countries. Then in the evening the same people leaving back to Bratislava. Back home they go to the supermarket and shopping. Spending their earned money from working in Austria, over the border in Slovakia as prices are substantially cheaper. For example a loaf of bread is 3 dollars in Austria and less than dollar in Slovakia. A true macroeconomic redistribution wealth.