It does seem kind of puzzling. However, there is one simple explanation. It´s a theory of why this happens, called the Balassa-Samuelson theory.

It takes about three steps to see it:

• The idea is, first, that the productivity for tradable goods is different in the two countries. It takes 100 hours of work in Switzerland to produce a computer. It tales 1000 hours of work in Venezuela to produce a computer. (This is easy to believe, you could think this is the result of Switzerland having more capital, infrastructure, etc.) Because these computers are tradable, they should have the same price everywhere, once expressed in dollars. So suppose the computer is worth $1000.

• The second step is to realize what this means for wages. It means that in Switzerland, people that make computers are payed $1000/100=$10 dollars an hour. (Assume the workers get payed the whole price of the computer...), and in Venezuela they get payed $1000/1000 = 1 dollar per hour (!).

• The third step is to realize a) that there are many goods that are non-tradable, like restaurant meals. They are usually services. These goods don't have to have the same price everywhere; and b) that there is not such as big difference in the productivity of these goods across countries. So it takes one hour of work to make a nice meal in Switzerland and the same in Venezuela. (One way to rationalize this is to see that if you want to invest a lot, you want to invest in producing something that can be sold-world wide, a tradable good. Therefore, rich countries have invested in increasing the productivity of tradable goods.) But now you have the result, because the price of a meal is $10 in Switzeraland (1 hour of work) and $1 in Venezuela (1 hour of work) (!!).

In sum, what the Big MAc index reflects is that the price of non-tradeables is different in a way that reflects the productivity differences in tradable goods.

Magic!

It does seem kind of puzzling. However, there is one simple explanation. It´s a theory of why this happens, called the Balassa-Samuelson theory.

It takes about three steps to see it:

• The idea is, first, that the productivity in the case of tradable goods is different in the two countries. It takes 100 hours of work in Switzerland to produce a computer. It takes 1000 hours of work in Venezuela to produce a computer. (This is easy to believe, you could think this is the result of Switzerland having more capital, infrastructure, etc.) Because these computers are tradable, they should have the same price everywhere, once expressed in dollars. So suppose the computer is worth 1000.

• The second step is to realize what this means for wages. It means that in Switzerland, people that make computers are paid 1000/100=10 dollars an hour. (Assume the workers get paid the whole price of the computer...), and in Venezuela they get paid 1000/1000 = 1 dollar per hour (!).

• The third step is to realize a) that there are many goods that are non-tradable, like restaurant meals. They are usually services. These goods don't have to have the same price everywhere; and b) that there is not such as big a difference in the productivity of these goods across countries. So it takes one hour of work to make a nice meal in Switzerland and the same in Venezuela. (One way to rationalize this is to see that if you want to invest a lot, you want to invest in producing something that can be sold worldwide, a tradable good. Therefore, rich countries have invested in increasing the productivity of tradable goods.) But now you have the result, because the price of a meal is 10 in Switzerland (1 hour of work) and 1 in Venezuela (1 hour of work) (!!).

In sum, what the Big Mac index reflects is that the price of non-tradeables is different in a way that reflects the productivity differences in tradable goods.

Magic!