Why are Big Macs supposed to cost the same around the world? The Big Mac index is frequently mentioned in media, but I could never understand how it makes any sense. According to Wiki:


  The Big Mac Index is published by The Economist as an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries.


Essentially the index is trying to say that if a Big Mac is more expensive in Switzerland compared to India, then the Indian rupee is undervalued or conversely that the Swiss franc is overvalued. But why would a Big Mac cost the same in all countries? Labor costs vary widely between different countries and so do costs such as real estate. There are even significant differences within the same country - a Big Mac in central London will cost you more than a Big Mac in a highway restaurant. 

So why is the index taken at face value by anyone? How does it measure anything except the cost of producing a burger in different countries?
Because of the Law of One Price, identical products are supposed to cost the same in different places. Since McDonald's applies standards for all the individual franchisees, the product is supposed to be identical even if it isn't perfectly identical. The law assumes there are no transportation costs. If lower costs exist in one place and there are no transportation costs you would move enough product until costs equalize. When the costs equalize the product price can equalize. This is not realistic for perishable products. The problems with this "law" are described in the limitations secton of the Big Mac Index entry in wikipedia.