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Burgernomics
For a number of years the British magazine The exchange rate, a Big Mac cost only $1.83. In
Economist has produced an annual comparison Switzerland, though, the price was $5.98.
of the cost in different countries of one particu- The Big Mac index suggested that the
lar consumption item that is found around the euro would eventually fall against the dollar:
world—a McDonald’s Big Mac. The magazine a Big Mac on average cost €3.31, so that
finds the price of a Big Mac in local currency, the purchasing power parity was $1.08 per
Photodisc
then computes two numbers: the price of a Big €1 versus an actual market exchange rate
Mac in U.S. dollars using the prevailing ex- of $1.39.
change rate, and the exchange rate at which Serious economic studies of purchasing
the price of a Big Mac would equal the U.S. U.S. price should offer some guidance about power parity require data on the prices of many
price. If purchasing power parity held for Big where the exchange rate will eventually end up. goods and services. It turns out, however, that
Macs, the dollar price of a Big Mac would be the In the July 2009 version of the Big Mac estimates of purchasing power parity based on
same everywhere. If purchasing power parity is index, there were some wide variations in the the Big Mac index usually aren’t that different
a good theory for the long run, the exchange dollar price of a Big Mac. In the U.S., the price from more elaborate measures. Fast food
rate at which a Big Mac’s price matches the was $3.57. In China, converting at the official seems to make for pretty good fast research.

Over the long run, however, purchasing power parities are pretty good at predicting
actual changes in nominal exchange rates. In particular, nominal exchange rates be-
tween countries at similar levels of economic development tend to fluctuate around
levels that lead to similar costs for a given market basket. In fact, by July 2005, the nom-
inal exchange rate between the United States and Canada was C$1.22 per US$1—just
about the purchasing power parity. And by 2008, the cost of living was once again
higher in Canada than in the United States.

figure 42.4

Purchasing Power Parity Exchange rate
versus the Nominal (Canadian dollars
per U.S. dollar)
Exchange Rate, C$1.60
1990–2008 Nominal exchange rate
The purchasing power parity between 1.40
the United States and Canada—the
exchange rate at which a basket of
goods and services would have cost 1.20
the same amount in both countries— Purchasing power parity
changed very little over the period 1.00
shown, staying near C$1.20 per US$1.
But the nominal exchange rate fluctu-
ated widely. 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Source: OECD.
Year

428 section 8 The Open Economy: Inter national Trade and Finance