Ppi and the Big Mac Index

Estimating the buy motive Parity (PPP) of currencies using the long mack major power Table of Contents 1. Introduction 2. Purchasing Power Parity and Theory of one Price 3. Over/Under Valuation of currencies against the buck 5. Comparative analysis of the most overvalued to the most undervalued 6. Observation and Alternative mightinesses 7. Limitations 8. adjunct INTRODUCTION Purchasing power parity (PPP) is an important and critical topic in international economics. It arises when the purchasing power of an amount of money is the same in different countries. This is when charges of devil different countries are converted to a special K currency.The idea is based on the law of one value, where in the absence of positive trade restrictions, similar goods will have the same impairment in different markets, with the prices being expressed in the same (common) currency. Deviations from parity infer differences in purchasing power of goods across countries, which means that for the uses of many international comparisons, countries GDPs or other national income statistics need to be PPP adjusted and converted into common units. There cannister be a huge difference when adjusted by purchasing power and when converted via market supplant pass judgment.For ex- If careful at nominal exchange rates, India has the tenth largest economy while adjusting by PPP, India has the fourth largest economy. Thus, to remove this discrepancy, a common currency of measurement is highly essential. The great(p) Mac Index is an example of a measure of law of one price. It refers to the prices of a plumping Mac burger in McDonalds restaurants in different countries. It helps in determine whether a currency is undervalued or overvalued and thus accordingly gives an idea about the direction in which currencies should move.The Big Mac was selected because it is available for a common purpose in many countries close to the world as local McDonalds franchisees have signific ant responsibility for converting input prices(at least in theory). The Big Mac Index is useful because it is based on a very well-known food item whose final price can be easily tracked in many countries. PPP and the Theory of One Price The One-Price Theory The theory of PPP and One price go hand in hand. It is imperative to discover the implication of One Price to understand the Purchase Power Parity as it is based on that.The Law of One Price proposes that if a toilet facility costs $2 in USA and the same gadget costs Rs 5 in India , so the exchange rate should be 2/5 = 0. 40 for the real prices to be same in both the countries. Let us denote it empirically as Price of a good in one country A be X and Price of the same good in some other country B is X* , then equalization of both the prices can be done using exchange rate denoted by the formula Exchange Rate = X/X* hazard in the above example where the exchange rate is calculated to be 0. 4, increases to 0. 6, and then the s ame gadget would cost Rs 8. 33 in India.This would result in the inflow of gadgets to India from USA causing increase in the demand of dollars and increase in supply of rupees. Law of One Price (LoOP) It states that identical goods should sell at same price in two different markets when there are no transportation costs and no differential taxes applied in two markets One Price Theory and PPP While this concept of one price here in the example is being applied to one commodity, it can be applied universally to all other commodities in market as well. The Big Mac burger is one of the brightest examples of the application of One-Price to a commodity.It looks at the price of a big Mac burger across different countries. This way Purchase Power Parity applies not just to a single commodity solely on general price level. This way we can universally derive a relation of One-Price theory and Purchase Power Parity. The Big Mac was created by Jim Delligatti in the year 1967 and introduced thr oughout the US in 1968. The Big Mac is now available in around 120 countries around the world and its newspaper publisher is generally the same throughout two all beef patties, special sauce, lettuce, cheese, pickles, onions on a sesame seed bun.Since beef is not consumed in India, a special Mac known as the Maharaja Mac can be found with chicken patties replacing beef patties. In Islamic countries the Big Mac is made with Halal beef and in Israel it is made with Kosher beef. The price of a Big Mac in US is calculated by the average of 4 cities Atlanta, New York, Chicago and San Francisco. The price of Big Mac in Euro area is calculated by the weighted average of prices in Euro area. The Big Mac considered in India is the Maharaja Mac. Country Big Mac Price Implied PPP rate + Todays Over(+) / Under(-) Valuation against the USD, % ++ Exchange Rate in Local gold in US dollars 1 USD = US $ 4. 07 4. 07 1 Argentina Peso 20. 0 4. 4153463 4. 92 4. 530 8. 6175 Australia A$ 4. 56 4. 6373416 1. 12 0. 983 13. 8996 Brazil Real 9. 50 5. 2511951 2. 34 1. 809 29. 3452 Britain ? 2. 39 3. 7447139 0. 59 0. 638 -7. 5573 Canada C$ 4. 73 4. 6363004 1. 16 1. 020 13. 7021 Chile Peso 1850 3. 6281104 455 509. 907 -10. 7681 China Yuan 14. 7 2. 3129209 3. 6 6. 356 -43. 3570 Colombia Peso 8400 4. 326 2066 1941. 748 6. 3990 Czech nation Koruna 69. 3 3. 6412205 17. 1 19. 32 -10. 1517 Denmark DK 28. 5 5. 1401734 7. 01 5. 545 26. 4302 Egypt Pound 14. 1 2. 3477628 3. 47 6. 006 -42. 2217 Euro area Euro 3. 44 4. 6013727 1. 18 0. 748 57. 8378 Hong Kong HK$ 15. 1 1. 9404672 3. 71 7. 782 -52. 3236 Hungary Forint 760 3. 3439474 187 227. 276 -17. 7213 India Rupee 84. 0 1. 6163756 20. 7 51. 968 -60. 1679 Indonesia Rupiah 22534 2. 501274 5543 9009. 009 -38. 4727 Israel Shekel 15. 9 4. 2277811 3. 91 3. 761 3. 9662 Japan ? 320 4. 1212269 78. 7 77. 647 1. 3564 Malaysia Ringgit 7. 20 2. 2981176 1. 7 3. 133 -43. 5046 Mexico Peso 32. 0 2. 3459637 7. 87 13. 640 -42. 3040 New Zealand NZ$ 5. 10 3. 9382574 1. 25 1. 295 -3. 4741 Norway Kroner 45. 0 7. 8321279 11. 1 5. 746 93. 1925 Pakistan Rupee 205 2. 3019159 50. 5 89. 056 -43. 2943 Peru New Sol 10 3. 7022146 2. 46 2. 701 -8. 9255 Philippines Peso 118 2. 7064108 29 43. 600 -33. 4865 Poland Zloty 8. 63 2. 5572242 2. 12 3. 375 -37. 1806 Russia Rouble 75. 0 2. 3810975 18. 5 31. 498 -41. 2663 Saudi Arabia Riyal 10. 0 2. 6661761 2. 46 3. 751 -34. 4121 Singapore S$ 4. 1 3. 4060498 1. 08 1. 295 -16. 5865 South Africa Rand 19. 45 2. 3850647 4. 78 8. 155 -41. 3850 South Korea Won 3700 3. 2782 910 1128. 668 -19. 3740 Sweden SKr 48. 4 7. 1816695 11. 9 6. 739 76. 5741 Switzerland SFr 6. 5 7. 036772 1. 6 0. 924 73. 2128 mainland China NT$ 75. 0 2. 4825847 18. 5 30. 210 -38. 7629 Thailand Baht 70. 0 2. 2628537 17. 2 30. 934 -44. 3985 Turkey Lire 6. 5 3. 5532705 1. 6 1. 829 -12. 5349 + The Purchasing Power Parity or the PPP rate is the price of Big Mac in local currency divided by the price in the US.Price of Big Mac (and corresponding impli ed PPP rates from The Economist and is the latest). ++ The Over/Under valuation against the dollar is calculated using Exchangerates latest rates ( i. e as of 09/12/2011) 100 x ( P P P Exchange Rate) / Exchange Rate (Source http//www. exchangerate. com/) OBSERVATION The most overvalued of currencies is the European Nordic countries currencies and most undervalued is the Indian Rupee. At market exchange rates, the Burger is 60% cheaper in India than in US. In other words, the Indian rupee is 60% undervalued against the dollar.However it should be noted that cheap burgers in India dont mean that the Indian rupee is highly undervalued. Average prices should be lower in poor countries than in rich ones because labor costs are lower. The chart in the Appendix A shows a strong positive relationship between the dollar price of a Big Mac and GDP per person. Purchasing Power Parity is positively an indicator where exchange rates should move in the long run. For estimating the current fair value of a currency, a best fit line is drawn between Big Mac prices and GDP per person.The price thus predicted after the best fit line is drawn is compared with the actual price and this provides a better estimation of the currency over and under valuation than the above index. The beefed up index shows that the Brazilian Real is the most overvalued in the world the Euro is also slightly overvalued. However the two major developing countries India and China appear to be almost equal to its fair values. ALTERNATIVE INDICES An index similar to the Big Mac index has also been developed by the financial company UBS as part of general compilation of differences in prices and incomes around the globe.The Economistalso comes out with variants of the same. For example in the month of January in 2004, it proposed aTall Latte indexby replacing the Big Mac with a Starbucks Tall Latte. Refer Appendix B for the same. Commonwealth Securities, an Australian banks subsidiary, proposed to creat e the iPod index by using the concepts behind the Big Mac index. The banks hostility that since the Big Mac index can be distorted by taxes, transport costs, labour laws and trade barriers in each country and the iPod was made in a single country China, it made more sense to use the iPod as a measuring index.Since the iPod was made in a single country, the price should be broadly be the same all over the world and if the price difference were substantial, customers would switch their purchases to other countries (thanks to internet). However it was found to be powerless since freight charges vary from country to country and countries such as US may get volume discounts. Bloomberg LP also introduced an alternative index known as Billy index after the iconic Ikeas bookshelf. The index was calculated after converting the bookshelfs price to US dollars. LIMITATIONS aapendix a appendix BAPPENDIX C (Exchange Rates as Of 9th December 2011) Country Currency ISO 12-08-2011 12-09-2011 % Change ARGENTINA Peso ARS 4. 52995 4. 529656 -0. 01% AUSTRALIA dollar AUD 0. 975877 0. 983322 0. 76% AUSTRIA Euro EUR 0. 74732 0. 747603 0. 04% BELGIUM Euro EUR 0. 74732 0. 747603 0. 04% BRAZIL Real BRL 1. 804477 1. 809112 0. 26% CANADA Dollar CAD 1. 014437 1. 02021 0. 57% CHILE Peso CLP 508. 4706 509. 9073 0. 28% CHINA Yuan CNY 6. 362878 6. 3556 -0. 11% CZECH REP. Koruna CZK 18. 90629 19. 3208 0. 67% DENMARK Krone DKK 5. 542461 5. 54456 0. 04% EUROPEAN UNION Euro EUR 0. 74732 0. 747603 0. 04% FINLAND Euro EUR 0. 74732 0. 747603 0. 04% FRANCE Euro EUR 0. 74732 0. 747603 0. 04% GERMANY Euro EUR 0. 74732 0. 747603 0. 04% GREECE Euro EUR 0. 74732 0. 747603 0. 04% HONG KONG Dollar HKD 7. 776135 7. 781631 0. 07% HUNGARY Forint HUF 227. 0945 227. 2763 0. 08% ICELAND krona ISK 119. 1911 118. 9654 -0. 19% INDIA Rupee INR 51. 73987 51. 96812 0. 44% INTNL MON.FUND SDR XDR 0. 642256 0. 642147 -0. 02% IRELAND Euro EUR 0. 74732 0. 747603 0. 04% ISRAEL Sheqel ILS 3. 775473 3. 760838 -0. 39% ITALY Euro EUR 0. 74732 0. 747603 0. 04% JAPAN Yen JPY 77. 60051 77. 64678 0. 06% KOREA (SOUTH) Won KRW 1132. 612 1146. 365 1. 21% KUWAIT Dinar KWD 0. 277164 0. 277164 0. 00% - MEXICO Peso MXN 13. 62357 13. 64045 0. 12% NETHERLANDS Euro EUR 0. 74732 0. 747603 0. 04% NEW ZEALAND Dollar NZD 1. 28856 1. 294989 0. 50% NORWAY Krone NOK 5. 70238 5. 745565 -0. 43% PAKISTAN Rupee PKR 89. 01636 89. 05625 0. 04% PERU Sol PEN 2. 701086 2. 701086 0. 00% - PHILIPPINES Peso PHP 43. 29727 43. 60018 0. 70% POLAND Zloty PLN 3. 360573 3. 374753 0. 42% PORTUGAL Euro EUR 0. 74732 0. 747603 0. 04% ROMANIA Leu RON 3. 23797 3. 23797 0. 00% - RUSSIA Ruble RUB 31. 43216 31. 49808 0. 21% SAUDI ARABIA Riyal SAR 3. 750569 3. 75069 0. 00% capital of Singapore Dollar SGD 1. 291813 1. 294755 0. 23% SLOVAKIA Euro EUR 0. 74732 0. 747603 0. 4% SOUTH AFRICA Rand ZAR 8. 204971 8. 154915 -0. 61% SPAIN Euro EUR 0. 74732 0. 747603 0. 04% SWEDEN Krona SEK 6. 771076 6. 73938 -0. 47% SWITZERLAND Franc CHF 0. 925818 0. 923719 -0. 23% TAIWAN Dollar TWD 30. 16208 30. 21045 0. 16% THAILAND Baht THB 30. 77703 30. 93439 0. 51% U. A. E. Dirham AED 3. 673236 3. 673236 0. 00% - UKRAINE Hryvnia UAH 8. 000472 7. 998369 -0. 03% fall in KINGDOM Pound GBP 0. 637984 0. 638233 0. 04% UNITED STATES Dollar USD 1 1 0. 00% -