Why Big Macs are used as a price index
As ridiculous as it sounds, it's the truth. The Big Mac index is a price index published by The Economist in 1986.
The Big Mac Index was created by Paul Woodall in 1986 as a more light-hearted method of measuring the power purchasing parity (PPP) of various currencies, originally being published in The Economist and since being used in their annual publications.
Albeit having started off as a humorous way to represent PPP, the Big Mac Index started gaining traction and now is globally recognised and featured in many textbooks and reports to display and compare the purchasing power of different currencies.
This article aims to why the Big Mac Index became so popular.
Why does it work so well?
To understand that, you first need to know what power purchasing parity is. According to the Organisation for Economic Co-operation and Development (OECD), PPP can be defined as “the rates of currency conversion that try to equalise the purchasing power of different currencies, by eliminating the differences in price levels between countries.”
In other words, it's essentially comparing how much a good costs in one currency with how much it costs in another.
This is where the problem lies, as finding an identical good in both countries which can be compared, poses a difficult challenge.
The OECD states that "3,000 consumer goods and services, 30 occupations in government, 200 types of equipment goods and about 15 construction projects" are used to calculate PPP. Clearly, calculating PPP is an incredibly complex and tedious task.
This is where McDonald’s beloved Big Mac comes in, with McDonald’s being THE prevalent international fast food chain.
Since the Big Mac does not vary from country to country, it serves as the perfect medium of comparison. It effectively simplified calculating PPP by a large margin. And so, it is still commonly used as a great example of how purchasing power can vary from currency to currency.