The Big Mac Index applies to the Law of One price to the hamburger business. This arbitrage actually operates as an instrument that regulates pricing across markets because once the pricing imbalance is noticed by either or both markets, the pricing will likely be adjusted to eliminate the discrepancy.
such as if you were able to buy a financial instrument in one market and sell it in another for a risk-free profit. This type of arbitrage refers to any transaction that exploits pricing imbalances that exist for a tradable item between two or more markets. However, the arbitrage I am discussing here is slightly different, and it is generally applied to financial instruments. For instance, if you wish to hire an online personal assistant, then you can save money by hiring someone from Eastern Europe since their wage requirements will be lower than someone from the US. Geoarbitrage is based on the same concept as arbitrage, but it focuses on the disparities in labor costs between countries, noting how exploiting these disparities will deliver a greater return on your time. Our regular readers might be familiar with the concept of geoarbitrage, a topic Andrew has written extensively on. This follows from the assumption upon which the law of one price is based – any variations in pricing that exist between two separate locations will inevitably be eradicated once enough participants in the market begin to exploit arbitrage opportunities that exist. In theory, however, even when prices are not currently the same across borders, over time they should move towards the same price. Therefore, it seems that this may generally be true for commodities such as gold, but it doesn’t always apply to other goods. However, I also know that a pint of beer in Geneva is going to cost me way more than a beer in Warsaw. This seems pretty straightforward since you would expect to pay the same amount for an ounce of gold in Australia as you would in Zambia.
The Big Mac Index is an example of how we measure the law of one price, which states that in the absence of any transport costs and trade tariffs and if free competition and price flexibility are present, then identical goods will cost the same price regardless of where you purchase them (once converted into a common currency). How to Use the Big Mac Index to Guide your InvestmentsĪt its most basic, the Big Mac Index is a way to gauge a currency’s over- or undervaluation using the Law of One Price, Purchase Power Parity, and the cost of the iconic Big Mac.
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