When reading this title, what idea brings to mind? Perhaps those in the financial or economic careers would say: "McDonalds' insignificant index list of boring burgers." The rest say probably say: "the image of Ronald McDonald, who is the typical binary of the friendly and scary looking clown."

After all, I guess this shows that McDonalds' (MCD) advertising and PR may be way more catchy and 'addictive' than their food. Though for those interested in finance, this Big Mac Index may be more important than just a mere burger.

The Big Mac Index does indeed refer directly to the McDonald's Big Mac. McDonald's is a substantial worldwide company making its mark over 70 - 80% of the globe. The McDonald's Big Mac is used as a benchmark for economics, which reflects on the different currency's worth and value. They were able to use the McDonald's Big Mac because it is sold in every store that exists.

The Economist's Infamous Annual Survey

When The Economist  first introduced The Big Mac Index in 1986. It was intended to be an engaging and entertaining way to calculate Purchasing Power Parity. Thirty-three years later and the Index has become one of the most reliable and cited global standards, relied upon by traders and taught in many economic textbooks.

What is Purchasing Power Parity (PPP)?

Purchasing Power Parity is an economic theory known as " The basket of goods." PPP is used as a guide to calculate and compare two currencies. The calculation is tested through the lens of a fixed set of consumer products and goods.

In the case of The Big Mac Index, the price of the famous McDonald's Big Mac is the benchmark used to determine PPP. The theory states - the exchange rate fluctuations between currencies ultimately affect the price that consumers will end up paying for a hamburger.

The Big Mac Index in Action

To illustrate the theory, let's consider the following example:

If the cost of a McDonald's Big Mac is $3.75 in the United States and £2.00 in Great Britain, the exchange rate is expected to be 1.875 (3.75 / 2). The Big Mac Index indicates that if the Gross Domestic Product (GBP) is overvalued, the exchange rate of dollar will rise. If the exchange rate of the dollar lowers, the Index tells us that the GBP is undervalued.

No Big intentions for the Big Mac

At first, the Index was intended to be lighthearted and fun because as it was far from perfect.

Yet more recently, traders use The Big Mac Index as a commodity indicator in currency investments.

McDonald's has the ability to influence the Index because they decide on the cost of this Big Mac burger. Another glaring imperfection is that the Big Mac burger does not have the same specifications. Each country has it’s own type of Big Mac burger, from their size, to ingredients, to the kind of bun.

For more information of this Index, read this article from MarketWatch.