The Big Mac index

Big Mac Index - a measure of exchange rates (actually purchasing power parity) between two currencies. It was defined by Economist's editor Pam Woodall to measure whether a currency is under- or overvalued. She used a Big Mac because the burger is produced in about 120 countries.

The easiest way to explain this is by an example. Say you want to know whether the exchange rate between the dollar and the British pound, say $2 = £1, is fair. You take the price of a Big Mac in the US ($3.57) and in Britain (£2.29). The idea is the price of a Big Mac should be equal in both countries, relative to their currencies - the implied purchasing power parity is 3.57/2.29 = 1.56. But the exchange rate is 2/1 - so this means that the pound is overvalued against the dollar by 28% (2 divided by 1.56).