The Big Mac Index


Another way of looking at prices and inflation with regard to different countries/regions is to consider the concept of Purchasing Power Parity (PPP).
Definition from Wikipedia:

"The purchasing power parity (PPP) theory uses the long-term equilibrium exchange rate of two currencies to equalize their purchasing power. Developed by Gustav Cassel in 1920, it is based on the law of one price: the theory states that, in ideally efficient markets, identical goods should have only one price."
A popular derivative of the PPP concept is the Big Mac Index, developed by The Economist Magazine. The Index is based on the notion that a dollar should buy the same amount in all countries and that in the long run; the exchange rate between two countries should move towards PPP rate and hence moves the prices of the same goods for each country towards equilibrium.
The Economist just published the latest Big Mac Index on January 22nd:

Based on the latest findings, Switzerland has the most overvalued currency whereas the currencies of South Africa, China and Russia (as part of the industrialized nations) are the most undervalued in relation to the US Dollar. Canada looks strong.

3 comments:

toronto realtor said...

I wonder what is better for Canada. Strong of weak currency? If we have strong currency, isn't that bad for our exporters?
Take care,
Julie

Anonymous said...

Parity is more of an emotional issues rather than an economic one...Canadians feel somehow "on par" with the Americans if our currencies are equal. A strange metric for comparison.

A strong dollar does make the heavy equipment and raw material we need for our manufacturing and natural resource industries, but a weak dollar makes the goods these industries make more attractive and competitive with goods produced in other parts of the world.

What is the best exchange rate for the CAD/USD for Canadian industry? That would be a great doctoral thesis. Where is the Canadian dollar equilibrium? At which point it is optimal for both our exporting and importing industries.

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