International Finance project
UNDERSTANDING CURRENCIES: BIG MACS AND DELL COMPUTERS
Background
The Big Mac Index is based on the theory of purchasing-power parity (PPP), which argues
that in the long run, exchange rates should move towards levels that equalize the prices of
an identical basket of goods and services in any two countries. The “basket” used by the
Economist is the Big Mac. The Big Mac PPP is the exchange rate that would leave burgers
costing the same in the United States as elsewhere. Thus, a Big Mac in China costs 11.0
yuan, against an average price in the U.S. of $3.22 (see column two in the exhibit). To make
the two prices equal would require an exchange rate of 3.42 yuan to the dollar, compared
with a market exchange rate of 7.77. In other words, the yuan is 56 percent “undervalued”
against the dollar. To put it another way, converted into dollars at market rates, the Chinese
burger is the cheapest in the table. By contrast, using the same method, the euro is
overvalued against the dollar by 19 percent. In this way, the Big Mac Index provides a truer
reckoning of currency values around the world.
The Index is not a precise predictor of currency movements. It is simply a guide to whether
currencies are at their “correct” long-run level. Interestingly, the Index has proven fairly
reliable in predicting exchange rates. Currencies that show up as overvalued often tend to
weaken in later years. It is natural for average prices to be lower in poorer countries than in
developed ones. The Big Mac index is most useful for comparing exchange rates between
countries with similar incomes per head. While the yuan and Russian rouble look
undervalued, the currencies of Norway, Sweden, and Switzerland look overvalued.
Big Mac Index
1
Country
United States
Argentina
Australia
Britain
Canada
China
Euro area
Japan
Mexico
New Zealand
Norway
Poland
Russia
Sweden
Switzerland
Big Mac prices
2
3
in local
in U.S.
currency
dollars
$3.22
Peso 8.25
A$3.45
£1.99
C$3.63
Yuan/RMB 11.0
€2.94
¥280
Peso 29.00
NZ $4.60
Kroner 41.5
Zloty 6.90
Rouble 49.00
Skr32.00
SFr 6.30
3.22
2.65
2.67
3.90
3.08
1.41
3.82
2.31
2.66
3.16
6.63
2.29
1.85
4.59
5.05
4
Implied PPP
of the dollar*
5
Actual dollar
exchange rate
6
Under (–) / over (+)
valuation against
the dollar, %
2.56
1.07
1.62
1.13
3.42
1.10
87.0
9.01
1.43
12.9
2.14
15.2
9.94
1.96
3.11
1.29
1.96
1.18
7.77
1.30
121
10.9
1.45
6.25
3.01
26.5
6.97
1.25
–18
–17
+21
–4
–56
+19
–28
–17
–2
+106
–29
–43
+43
+57
Prices and exchange rates as of 2007
* Big Mac price in local currency divided by the U.S. dollar price ($3.22)
SOURCE: Economist (2007), “The Big Mac Index,” February 1, obtained from
www.economist.com
Your Task and Methodology
Your task is to create your own Big Mac Index, using the prices of a single model of Dell
computer. Pick five of the 15 countries listed in the Big Mac Index, or choose five countries
on your own. For these five countries, replicate the table above. You may find it useful to
create your table using spreadsheet software. You are to perform the following tasks:
Use the template table given below. Visit the websites listed below and collect or
calculate data for each of the variables in the table, for all five of your chosen
countries. List your countries in column 1. Use the United States as your first
country, and U.S. dollar as your base price. For the U.S., obtain data for columns 2
and 3 only.
For column 2, look up the price of a Dell computer at the Dell website for each country.
To do this, visit the main Dell website (www.dell.com) and click on ‘Choose a
Country’. Choose a Dell computer that can be found on Dell’s websites worldwide.
For example, you might choose the ‘Dell Inspiron 1501, with a 15.4” screen’. Be sure
to check the price for the same model in each country.
For column 3, translate the price of the Dell computer obtained in column 2 into U.S.
dollars by obtaining the current exchange rate of the currency to the U.S. dollar.
Obtain the current exchange rate by visiting a currency converter online, such as the
Universal Currency Converter at www.xe.com. Cite the source of your currency
conversions, and be sure to convert currencies correctly (for example, yen per dollar,
not dollars per yen).
For column 4, calculate the Implied PPP of the Dollar by dividing the chosen Dell
computer price for each country by the price for the Dell computer in U.S. dollars
($499 in the example table).
For column 5, insert the actual dollar exchange rate for the current date for each
respective country, from the currency conversion website that you used for step 3.
For column 6, compute the valuation difference by calculating the percentage difference
between the implied PPP of the dollar (column 4) and the actual dollar exchange rate
(column 5). For example, subtract column 5 from column 4 and divide the result by
column 5.
Once you have completed your table, answer the following questions:
1. Did anything surprise you in the results you uncovered? Did any prices seem unusually
high or low? Please elaborate.
2. In case of a large Dell price differential between two or more countries, what do you think
accounts for this difference? Justify your answer.
3. What is purchasing power parity? Why is it a superior measure of foreign prices than
those interpreted via exchange rates? (Feel free to refer to this textbook to answer this
question).
Suggested Resources for this Exercise
Website of Dell Inc. at www.dell.com.
Currency converter online, such as www.xe.com or www.x-rates.com
You may also wish to consult the article on the “Big Mac Index” at the Economist,
www.economist.com
Template
Use the template below to complete this exercise.
1
Country
Price of Dell Computer
2
3
in local
in U.S.
currency
dollars
4
Implied PPP
of the
dollar*
5
Actual dollar
exchange
rate
6
Under (–) / over
(+) valuation
against the
dollar, %
The resulting table should look something like the following. Note the numbers below are
exemplars only; They are not actual Dell prices and do not represent the correct solution.
You should use any five countries of your choosing.
1
Country
United States
Australia
Canada
United Kingdom
Japan
Mexico
Price of Dell Computer
2
3
in local
in U.S.
currency
dollars
$499
A$799
C$549
£399
Yen 75,980
Peso 7,299
$499
898
528
814
666
674
4
Implied PPP
of the dollar*
5
Actual dollar
exchange
#
rate
6
Under (–) / over (+)
valuation against
the dollar, %
1.60
1.10
0.80
152.26
14.63
0.89
1.04
0.49
114.06
10.83
+80
+6
+63
+33
+35
* Dell computer price in local currency divided by the U.S. dollar price ($499)
# Actual exchange rate obtained from an online exchange rate converter
Then, answer the questions given above.
Note that in the real world, various factors, often difficult to predict, play a key role in
determining currency values. These include government intervention, interest rates,
inflation, and market psychology. Signs that a country’s currency is going to lose value
include declining business activity in the country, stalled economic growth, or rising
unemployment. The currency will also lose value if the country's level of output is expected
to decline, or if it is troubled by political uncertainty. In addition, one can argue that Big Macs
and Dell Computers are imperfect indicators of exchange rates. The reason is that both
McDonald’s and Dell employ unique pricing strategies in individual markets, contingent on
local purchasing power, competitors’ prices, marketing strategies and tactics, and other
factors. These differing prices are likely to distort the “exchange rate” that might be inferred
by comparing Big Mac and Dell prices to those in other countries.