Question

What is the purpose of a PPP index? How does the BigMac index fit into it and allow us to determine "over/under valued currency

Answer 1

purpose

The concept of purchasing power parity makes it possible to estimate what the exchange rate between two currencies should be in order to equalize the purchasing power of the two currencies.

how bigmac index fit into it

the idea behind the BigMac index is to identify the different purchasing power of the people in different countries the basic concept is like a PPP index only it can be considered as the example of the PPP index.

The Economist publishes The Big Mac Index as an informal means of measuring purchasing power parity (PPP) between two currencies and verifying the extent to which market exchange rates make goods cost the same in different countries. At last it compares the purchasing power of the people in context of number of BigMacs they can purchase with thier currency.

under/over valued currency

For example a single us dollar is able to purchase a 4 BigMacs while the Euro is a to purchase the 8 BigMacs so the exchange rate should be 1£=2$. Now if existing exchange rate is 1£=2.5$ so it's called the euro is overvalued, and if the existing exchange rate is 1£=1.5$ that means the euro is undervalued.

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