Some of the complex issues in Economics have very simple basics which if someone wants to deeply understand them have to go back to basics. I came across Bic Mac index while i was researching on exchange rate theories. If you want to understand the basic root of exchange rate, it's better you go back to a time when there was good by good exchange. One of the very first theories which still in my opinion make sense in so many areas is the theory of purchasing power parity (ppp).
The long run exchange rate between two countries can be measured by the value of an identical basket of goods (e.g. Big Mac). According to Economist, as of July 2013, Bic Mac would cost 7.51$ in Norway and 6.72$ in Switzerland compared to its average price of 4.56$ in America. This means that the Norwegian currency (Krone) is 65% overvalued compared to U.S dollar. Which country has the most undervalued currency? South Africa and India.
What this means? Perhaps (assuming floating exchange rates) the ingredients of Big Mac and cost of producing of Big Mac in South Africa or India is cheaper than cost of producing it in US itself.
Source: Economist, July 13th-19th 2013 edition
The long run exchange rate between two countries can be measured by the value of an identical basket of goods (e.g. Big Mac). According to Economist, as of July 2013, Bic Mac would cost 7.51$ in Norway and 6.72$ in Switzerland compared to its average price of 4.56$ in America. This means that the Norwegian currency (Krone) is 65% overvalued compared to U.S dollar. Which country has the most undervalued currency? South Africa and India.
What this means? Perhaps (assuming floating exchange rates) the ingredients of Big Mac and cost of producing of Big Mac in South Africa or India is cheaper than cost of producing it in US itself.
Source: Economist, July 13th-19th 2013 edition