Rajeet Guha

A.1 The Big Mac Index is synonymous with the Big Mac Purchasing Power Parity. It is grounded in the theory of Purchasing Power Parity (PPP), which adjusts price level differences across countries. The theory of PPP purports that in the long-run market foreign exchange rates will move towards rates that equalize the prices of an identical basket of goods and services across countries exemplified by the prices of burgers across countries. The proponents of PPP point out the drawback in calculating national output at prevailing market foreign exchange rates namely not accounting for the discrepancies in price levels across countries and therefore either understating or hyperbolizing the contribution of GDP of countries to the world output. The adherents of the theory of PPP believe that the law of one price should be incorporated in the calculation of the GDP of countries. They assert that GDP computed at PPP will mirror the true contribution of the country’s economy to world output.

A.2 The Big Mac index is a befitting title. It is founded on the supposition that in the long run market foreign exchange rates will kowtow before the law of one price. The law of one price claims that the prices of goods across countries will converge in the long-run. A corollary that comes out of this is that the prices of Big Mac burgers across countries will be the same in a universally accepted currency such as the dollar. The Big Mac has been used as an example to drive home the strong case for purchasing power parity.

A.3 Certain key insights can be gleaned from the article in the economist titled ‘Food for Thought’. The article rams home the issue of abandoning the estimation of GDP at exchange rates that fail to take into account disparities in price level across countries and endorses the calculation of GDP at purchasing power parity. The advocates of PPP contend that GDP at PPP will reveal the latent size of an economy and its share in the world output pie. They are convinced that there will be a clear-cut picture showing by how much an average consumer in one country is better off in real terms than his counterpart in another country. They also feel that the unearthing of the baffling surge in oil prices lie in the novelty of purchasing power parity. They feel the mind-boggling populous nations of China and India have catapulted the enormous bulge in oil prices. However, the verbose eulogy on PPP is not without a blemish. PPP does have an Achilles heel. It does not hold forth for goods and services that are precluded from the realm of trade.