Index Number

An Index Number expresses the relative change in price, quantity, or value compared to a base period.

36-Month CPI 2000-2002

4 3
CPI

2 1 0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Month beginning 1/1/2002

A Simple Index Number measures the relative change in just one variable.
Index Numbers

Mr. X owns stock in three companies. Given is the price per share at the end of 1997 and 2002 for the three stocks and the quantities he owned in 1997 and 2002.

Stock

1997 1997 2002 2002 Price Shares Price Shares

NWS NPC GAC

$1 $5 $6

30 15 40

$2 $4 $6

50 30 20

Simple indexes using 1997 as base year (1997=100) Price Share ($2/$1)(100)=200 (50/30)(100)=167 (30/15)(100)=200 ($4/$5)(100)=80 (20/40)(100)=50 ($6/$6)(100)=100
Example 1

Easier to Indexes comprehend than actual numbers $345,651,289,560 (percent or 10%? change) Facilitate comparison of unlike series
Bread
Car Dress Surgery

Why compute indexes?

Provide convenient ways to express the change in the total of a heterogeneous CPI group of items

$0.89
$18,000 $200 $400,000

Why Convert Data to Indexes?

Indexes: Four classifications

Price Measures the changes in prices from a selected base period to another period.

Quantity Measures the changes in quantity consumed from the base period to another period.

Special purpose Combines and weights a Value heterogeneous group of series Measures the change in the to arrive at an overall index value of one or more items showing the change in from the base period to the business activity from the given period (PxQ). base period to the present.
Types of Index Numbers

Simple Price Index

From Example 1 a simple aggregate price index for the three stocks
p t KP (100) p 0 $2 $5 $6 (100) $1 $5 $6 100.0

where po the base period price pt the price at the selected or given period.

Construction of Index Numbers

Weighted index
Upward bias

Considers both the price and the quantities of items Laspeyres Weighted Price Index

Two methods of computing the price index Laspeyres method Paasche method

Uses the base period quantities as weights

where pt is the current price p0 is the price in the base period q0 is the quantity consumed in the base period

Paasche Weighted Price Index, P

Present year weights substituted for the original base period weights

Downward bias

where qt is the current quantity consumed p0 is the price in the base period pt is the current price.
Construction of Index Numbers

Fishers Ideal Index

Fishers ideal index = (Laspeyres index)(Paasches index)

The geometric mean of Laspeyres and Paasche indexes

Balances the negative effects of the Laspeyres and Paasches indices.

Fishers Ideal Index

Value Index
Reflects changes in both price and quantity Both the price and quantity change from the base period to the given period

Value Index

Exercise: Compute the CPI

Basket contains 20 pizzas and 10 compact discs.

prices: 2002 2003 2004 2005

pizza $10 $11 $12 $13

CDs $15 $15 $16 $15

For each year, compute the cost of the basket the CPI (use 2002 as the base year) the inflation rate from the preceding year

Exercise: Compute the CPI

Cost of basket

CPI

Inflation rate

2002 2003 2004 2005

n.a.

Answers:

Exercise: Compute the CPI

Cost of basket

CPI

Inflation rate

2002 2003 2004 2005

$350 370 400 410

100.0 105.7 114.3 117.1

n.a. 5.7% 8.1% 2.5%

Answers:

Usefulness of CPI
It allows consumers to determine the effect of price increases on their purchasing power. It is a yardstick for revising wages, pensions, and other payments. It computes real income: real income = money income/CPI (100)

It is an economic indicator of the rate of inflation.

Consumer Price Index

Example: Solution
Mr. X owns stock in three companies. Shown below is the price per share at the end of 1997 and 2002 for the three stocks and the quantities he owned in 1997 and 2002.
Stock 1997 1997 2002 2002 Price Shares Price Shares

NWS NPC GAC

$1 $5 $6

30 15 40

$2 $4 $6

50 30 20

Laspeyres Weighted Price Index, P

p t q 0 Kp (100) p 0 q 0 $2(30) $4(15) $6(40) (100) $1(30) $5(15) $6(40) $360 (100) 104.35 $345

Paasche Weighted Price Index, P Example: Solution pt qt

Kp p0 qt (100) $2(50) $4(30) $6(20) (100) $1(50) $5(30) $6(20) $340 (100) 106.25 $320

Value Index
pt qt K (100) p 0 q 0 $2(50) $4(30) $6(20) (100) $1(30) $5(15) $6(40) $340 (100) 98.55 $345
Example 1 continued

Fishers Ideal Index

F = (104.35)(106.25) =105.3

Practice Exercise
Prices (Rs. per kg/lit.) kg/lit.) Milk Butter Cheese 2000 3.95 61.5 34.8 2005 3.89 62.2 35.4 2010 4.13 59.7 38.9 2000 9675 117.7 77.93 2005 9717 115.5 74.39 2010 10436 115.5 82.79 Quantities produces (millions of

Calculate Laspeyre and Paasche price Index for 2010 with 2000 as base.

Practice Exercise
Prices (Rs.) 2005 2010 200 220 300 340 10 8 Quantities (units) 2005 2010 20 12 30 36 100 60

Wheat Rice Cloth

Calculate Fishers price Index for 2010 with 2005 as base.