The Big Mac index, developed by the Economist magazine in 1986, is based on the theory of the purchasing power parity (PPP), the notion that a dollar should buy the same amount in all countries. As such, the Big Mac PPP is the exchange rate that would leave the identical hamburger costing the same in the US and abroad, or that ensures the ‘law of one price’. Not only the Big Mac index is simple and easily digestible, but it has also proven to be quite robust in terms of its predictions and implications — almost just as good as more sophisticated methods . Of these implications, two are very important: first, the extent of undervaluation or overvaluation of the exchange and the direction that it will take to reach its PPP rate in the long-run; second, the cost and exchange rate differences that underlie the undervaluation/overvaluation and how they are ultimately corrected for.
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