One of the oldest concepts in international economics is the theory of purchasing-power parity (PPP). PPP argues that, in the long run, exchange rates should move towards levels that would equalise the prices of an identical basket of goods and services in any two countries.
The Economist uses just one item: the Big Mac.
If a Big Mac costs £2.50 in the UK, at today’s exchange rate (£1 = $1.46677), a Big Mac in the US should cost $3.67.
If it costs more than $3.67 then the PPP concept suggests that the pound is overvalued (or the dollar is undervalued). The consequence of this is that, all things being equal, either the pound will go up, or the dollar will fall.
Too simple? Possibly, but as a measurement of exchange rates, Big Maconomics has endured.
Sometimes I think we make life too complicated and not enough fun.
