What does the Big Mac index illustrate?

The Big Mac index is a lighthearted but insightful tool that illustrates the concept of purchasing power parity (PPP) by comparing the prices of a Big Mac burger across different countries. It serves as a measure to determine whether a currency is undervalued or overvalued relative to another. The reasoning behind using a Big Mac is based on the idea that the same product should cost roughly the same in different countries when exchange rates are valid.

When the price of a Big Mac is significantly higher in one country compared to another when adjusted for currency exchange rates, it suggests that the currency of the more expensive country may be overvalued. Conversely, if the price is significantly lower, it indicates that the currency may be undervalued. This index simplifies complex economic concepts into something tangible and relatable, making it easier for individuals to understand exchange rate discrepancies.

Other choices may cover important economic topics, but they do not capture the essence of what the Big Mac index specifically illustrates. The index is not primarily about interest rates, inflation in general, or trade balances, but focuses on the relationship between currency valuation and purchasing power as depicted through a common consumer good.