In order to level the playing field between different countries’ cost of living, inflation and its currency value, a formula called the Purchasing Power Parity or PPP was developed. The PPP exchange rate is calculated using the formula: the cost of product 1 in currency x divided by the cost of product 2 in currency y. The Big Mac or the iPad Index are popular ways of exploring the ‘correct’ conversions.
For example…
Let’s take the cost of the popular McDonald’s burger the Big Mac in China. Say that it costs about five US dollars on the streets of New York. In China, the same Big Mac costs about, say two dollars and seventy-five US, when converted at market exchange rates. According to the Purchasing Power Parity, this suggests the Chinese Yuan is undervalued by about forty-five percent.
