Economist Magazine is a famous publisher that invented the BIG Mac Index. This index is used to compare the market value of different currencies. Why the name BIG Mac? Well, many economists believe that the price of a McDonald’s burger is a good indication of how much purchasing power a certain currency possesses. For instance, a McDonald’s burger in china might be more expensive than a McDonald’s burger in Canada. The Big Mac Index does have its shortcomings. A Big Mac's price reflects more than just the cost of bread and meat and vegetables. It also reflects non-tradable elements -- such as rent and labor. For that reason, the Big Mac Index probably is best when comparing countries at roughly the same stage of development. In any case, there is no theoretical reason why non-tradable goods and services should be equal in different countries. That explains why PPPs (Purchasing power parity) are different from market exchange rates over time.
The Big Mac Index is basically based on the purchasing power parity theory. This seems like a complicated theory of exchange rates, and price levels, but in all actuality it is very simple. Purchasing power parity is an economic technique used when attempting to determine the relative values of two currencies. It is useful because often the amount of goods a currency can purchase within two nations varies drastically; based on availability of goods, demand for the goods, and a number of other difficult to determine factors.
Purchasing power parity solves this problem by taking some international measure (the McDonald’s Big Mac) and determining the cost for that measure in each of the two currencies, then comparing that amount. Basically, Purchasing power parity (PPP) is a theory of exchange rate determin ...