Big Macs and Foreign Exchange in looking at Global Trade

Council for Economic EducationConference: Baltimore, MD

October 5, 2013

International prices and wage comparisons

• A tricky area indeed to understand as well as to teach

• A look at PPP• Purchasing- power parity• How we use it?• Why use it?• Link it to class and topics in studying global

trade, for both AP economics and economics

Burgernomics!

• The Economist has used the BIG MAC for years as its way to analyze foreign exchange rates

• As they put it, the ‘secret sauce’ of their analysis is the theory of purchasing-power parity.

• Which begs the question, what is purchasing-power parity?

Our basket of good and service to analyze has just ONE item: BIG MAC!

Purchasing-power parity

• It is looking at two nations currencies at the “nominal” exchange rate at which a given market basket of goods and services would cost the same amount in each nation.

• Instead of using a market basket of a variety of goods and services, the Big Mac index uses one:

• The Big Mac! ( Except in India…)

Why look at the Big Mac index?

• It is useful and an easier way to illustrate a key area in open economies or studying the foreign exchange market

• International exchanges require a market—the foreign exchange market—in which currencies can be traded for each other.

• The price at which these trades are made are known as the exchange rate.

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USDYen

D$

S$

DYen

SYen

D$1 SYen1

Currency Markets Supply and Demand

• Let’s take a look at foreign exchange rates and use this activity:

• THE FOREIGN EXCHANGE MARKET1. Skim over the first side of this APE handout.2. Working together ( if possible ) and use your

brain or calculator-----find the changes in currency values from May to August and see if

3. the currency APPRECIATED or DEPRECIATED!

Some observations to be noted..

• When a currency appreciates or depreciates, it changes the price of imports and exports.

• Why is this critical to understanding foreign trade?

• Depreciation or appreciation of a currency will impact the economy since it impacts net exports.

So, is there another way to look at this issue of exchange and currency values?

• Yes, why yes there is!• Let’s look at the BIG MAC!

Let’s compare using the Big mac index

• We will look at a few nations to see whose currency is under or over valued against the dollar ( BIG MAC )

• Volunteers?• Let’s put them in order with the US in the

middle to represent the average base price of the sandwich

• Use handout A to see the table and let’s put these volunteers in their place!

Results?

• Which nations are above ( overvalued ) v the Big Mac?

• Which nations are below ( undervalued ) v the • Big Mac?• What is the average price in the US?• Highest one in our simulation? On the chart?• Lowest one in our simulation? On the chart?

Let’s go to real time and calculate the prices and see who is over or under valued?

• Using the activity from EconEdLink, we are going to use current prices, world capitals and Big Macs to look at selected currencies.

• 1. Work with a partner• 2 In our session, we can use a calculator ( but

in class, decide if you want to or not )• 3. We are going to look at 10 nations, capitals

and currencies

Using these nations, what are their capital cities?

• Australia?• Denmark?• Argentina?• Mexico?

• Sweden?• Malaysia?• Italy?• Thailand?• Hungary?

And the answers are:

• Australia ( Canberra )• Denmark ( Copenhagen)• Argentina ( Buenos Aires)• Mexico ( Mexico City )

• Sweden ( Stockholm )• Malaysia ( Kuala Lumpur)• Italy ( Rome )• Thailand ( Bangkok)• Hungary ( Budapest )

As we move to end this session, let us consider…..

• Purchasing power parity is a theory and model of exchange rate determination.

• The Big Mac index developed by The Economist is a fun way to study a tradable good and prices between locations in different nations.

• It can add to your teaching of exchange rates and open economies/global trade

Suggestions for additional resources

• The Economist. Search their website for more as well as print issues ( www.economist.com )

• www.econedlink.org/lessons for the lesson on the Big Mac index

• Youtube.com has several clips on purchasing power parity for you as a teacher to look over for enrichment or learning

Textbooks

• Krugman’s Macroeconomics for AP. Ray, Anderson, Krugman and Wells. BFW Worth. 2013. Pages 427-428.

• Economics: Principles in Action. Sullivan and Sheffrin. Prentice Hall. 2008. pages 458-461.

APE materials to consider

• Advanced Placement Macroeconomics: Student Resource Material.

• Lesson 7-3.

• CEE. 2012

Thank you for your time and effort in this session

• Hopefully you have a better sense of the Big Mac index, purchasing power parity and foreign exchange rates from today

• You can do this• Do good things daily• It is about progress over time• Contact me?• Bruce Damasio at Maryland Council on Economic

Education. ( Towson U ) bdamasio@towson.edu• Take care and thanks again for coming this morning!