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The Big Mac index helps support the position that in the long run exchange rate prices should match the price of the same basket of goods in a different country. The Big Mac index does this since it is using big macs as the different goods in 2 countries and comparing the price to decide the exchange rate. This can be used to determine whether a currency is overvalued or under. For example, if a Big Mac is 2X as expensive in one country as it is over here in the states, and an exchange rate that is less than 2 would make the US Dollar be undervalued. This method, however, does need to take into account the fact that some prices are cheaper just based on location, one of them being labor. In order to deal with the difference in labor prices for less wealthy countries, the GDP - adjusted index can be used to help determine a more realistic exchange rate off of one product.

 

The difference in price for two goods is also impacted by inflation. He Big Max Index does a good job of reflecting the inflation in one country in a quicker manner, which is another key aspect to why it can be used to determine exchange rates. The International Fisher Effect claims that if the nominal interest rate changes then exchange rates should move similarly. The nominal interest rate takes into account inflation, which a Big Mac will take into account as well. This correlation is seen in many indexes, not just big macs, where as inflation increases so does the price. Index prices such as the CPI, will often be used to help determine inflation. Personal income and prices often share a positive correlation as well. This is due to the laws of supply and demand, as increased income often leads to more spending which in turn causes prices to increase. 

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