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Week 5:
International Financial Management (Learn how companies decide if…
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Big Mac Index
Over time, costs in high cost countries tend to drop and costs in low cost countries tend to increase as individuals and companies figure out ways of getting around legal restrictions.
Examples include moving factories outside the United States, traveling outside the U.S. for health care, and Mexican labor sneaking over the U.S. border.
A common mechanism to attempt to compare violations of PPP worldwide is the Big Mac Index that shows the price of a Big Mac in many countries.
The price will be influenced by both the cost of food and the cost of labor.
Six most expensive countries according to the Big Mac Index 
Big Mac Index Least Expensive
Purchasing Power Parity
Pdollar = S(dollar/euro) * Peuro
Pdollar = Price item of US Dollar
Peuro = Price item of Euro
S(dollar/euro) = Spot exchange rate between US Dollar & Euro
The Idea of Purchasing Power Parity (PPP) is that products should cost the same all over the world.
In a free market, if this were not true, arbitrage would take place (i.e. goods and services would be purchased in one location and moved to another location for a profit).
Adam Smith discussed this in his book, Wealth of Nations, in 1776. If gold was more expensive in one country than another, it would be purchased in the cheap location and shipped to the more expensive location.
Hence the price of a product in dollars should equal the price of the same product in euros times the exchange rate.
General Untrue
Because currencies can generally move freely from one country to another, but people and products cannot.
Pharmaceuticals and physician’s services are much cheaper overseas than in the United States, but it is illegal to buy drugs overseas and sell them in the United States. Clothing and electronics are commonly much cheaper in the United States than in Africa or the Middle East, but there are many restrictions on buying these products in the U.S. and selling them in those locations. There are also restrictions on cheap labor moving from India or Mexico to the United States.
Index of Economic Feedom
When Investing in different countries businesses must consider the cost of taxation and the risks of not getting their investments back. A common starting point when examining these risks are the various Indexes of Economic Freedom which examine issues such as a company’s:
On average, the more economic freedom a country possess, the easier it is to start and operate a business in that country.
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