- Peer Review: “Purchasing Power Parity Using The Big Mac Index”
Purchasing Power Parity Using The Big Mac Index
- Nov 2, 2001 by Business
- This is a complete lesson plan from the National Council of Economic Education that illustrates the concept of purchasing power parity. Key economic concepts covered are provided as well as lesson objectives. There is a teacher?s version, student?s version and printable version.
This module is designed to explain the economic concept of purchasing power parity: The exchange rate should adjust the value of currencies between two countries so that the price of an identical good in each country is the same. A link is provided to Bloomberg?s cross currency exchange rate page, and questions for discussion are provided. After an explanation of purchasing power parity, the lesson uses the Big Mac Index published annually by The Economist for a classroom activity. The index is constructed by computing the ratio of the average price of McDonald?s Big Macs in a country to the average price in the U.S. with the currency exchange rate. This can then be used to gauge whether the current value of the exchange rate is an accurate reflection of the relative price of Big Macs. There is a worksheet provided to help calculate whether or not a currency is under- or over-valued. It is not a scientific index of the value of the exchange rate, but it uses a fairly intuitive example to promote improved understanding of the forces that may influence exchange rates.
- Type of Material:
- The material is a lesson plan that incorporates a drill and practice assignment. It makes use of a real-world application of a key economic concept.
- Technical Requirements:
- A current web browser (e.g. IE or Netscape, version 3.x or higher) is required.
- Identify Major Learning Goals:
- The goal of the module is to increase the learner?s understanding of exchange rates. The module makes use of the introductory concept of purchasing power parity to motivate a comparison of the prices of goods and services throughout the world. Some specific learning goals are:
1. Explain that over long periods of time, the dollar price of specific goods and services should equalize across countries.
2. Explain that current deviations from purchasing power parity may help explain future exchange rate movements.
3. Explain that when foreign exchange rates between countries change, the relative prices of goods and services between those countries also change.
- Target Student Population:
- Although designed for use at the high school level, students studying introductory macroeconomics or international trade at the college level could also benefit.
- Prerequisite Knowledge or Skills:
- A general understanding of exchange rates would be helpful. Students should be comfortable computing ratios, percentages and percent changes. They should also be able to convert from one currency to another.
- The module is completely self-contained. Direct links to outside required material are available. The module does an excellent job of explaining the concepts in everyday language and adding interesting support by referring the learner to other excellent web resources. The module is divided into three sections?the first discusses PPP in general using a cell phone example, the second discusses the Big Mac Index, and the third is an assignment using the Big Mac Index. This allows the user to understand the general concept in a three country setting before moving on to the Big Mac application and a learning assignment dealing with nine countries. The module uses commonly accepted economics terms and definitions, and displays a thorough understanding of the concept. Answering the questions will help the students learn.
- While the use of the Big Mac can help make PPP relevant, some of the references are becoming dated. The site appears designed to make use of 1999 data. While currently that data is still available, it would be beneficial to move the reference year to a more current date (2001).
(COMMENT FROM AUTHOR: This is hosted on an organization's website and author has no control over the date's although he has requested it be updated).
Potential Effectiveness as a Teaching Tool
- This is an excellent design for an instructional website in economics and a very creative way to teach the concept. Both teacher and student versions are provided, and printable versions of both were also made. Kudos! The instructor version explicitly states the learning objectives. The step-by-step nature of the site, with its hyperlinks to helpful sites, will greatly assist the student in self-paced learning. Questions for discussion are provided, and in the teacher?s version, the appropriate answers are also provided. With the data provided, additional assignments could be provided. Additional learning will take place, as students identify the country by its capital.
- The module assumes a familiarity with exchange rates and indexes and requires mathematical skills beyond college algebra to successfully complete the assignment. The mathematical construction of the PPP index numbers and percent changes may require further instructions. Also, at time it is unclear whether current or 1999 data is supposed to be used. For example, in Problem 1 of the first section, a question is asked in the student version and a point is made that the answer depends upon the current exchange rate. It later reports the correct exchange rate using 105.2 yen per dollar, but never explains that this was an old exchange rate and that your answer will likely differ.
Ease of Use for Both Students and Faculty
- A key feature of this website is functionality. The instructions are very easy to follow. It has minimal graphics and no multimedia features (audio, video, animation) to tie up bandwidth. Links are provided to the additional information required. Most of the links are current, and even allow you to use 1999 data from other websites so that you can follow the examples on the module. For example, The Economist website keeps older versions of its Big Mac index which allows the student to examine the 1999 data referred to by this module. Kudos to the author for selecting data resources that remain relevant despite the highly dynamic nature of the web. Because the Big Mac Index is updated annually, the information is never out of date.
- The module might be a little more user friendly, if some interaction other than the links were provided. There is an inherent risk in referring to Internet resources that are beyond the control of the author. These websites may change in the future,
so infrequent updating of the links and the descriptions on the website is necessary. The website gives the impression of not being updated since 1999. (Lesson Posted: Nov. 30, 1999.) Recommend annual updating, if feasible.
(SEE AUTHOR'S COMMENT ABOVE)