The Big Mac index relies on which economic principle?

The Big Mac index is based on the law of one price, which posits that in an efficient market, identical goods should sell for the same price when expressed in a common currency, assuming no transportation costs and barriers to trade. This index uses the price of a Big Mac in various countries to compare purchasing power parity (PPP) and assess the relative value of currencies.

By analyzing the price of a Big Mac in different countries, the index illustrates how exchange rates can overstate or understate the purchasing power of currency. If a Big Mac costs significantly more in one country than another, it suggests that the currency may be overvalued or undervalued relative to others, given that this product should, in theory, have a similar price across borders.

The other options refer to different economic principles. The law of diminishing returns relates to production processes, the law of supply and demand describes price formation in a market, and the law of comparative advantage pertains to trade efficiencies. While these concepts are important in economics, they do not specifically relate to the mechanism behind the Big Mac index, which fundamentally relies on the principle that identical goods should have a uniform price across different markets.