CEC 3106:Economic Statistics I

Lecture seven: Index Numbers

Abdiaziz Ahmed
Department of Economics and Development Studies
University of Nairobi
Email: [email protected]

Venue:LT 301
May 08th 2024

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Table of Contents

1 Content of Lecture seven

Price Relatives
Aggregate Price Indexes
Some Important Price Indexes
Price Indexes: Other Considerations
Quantity Indexes

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Price Relatives

Price relatives are helpful in understanding and interpreting changing

economic and business conditions over time.
A price relative shows how the current price per unit for a given item
compares to a base period price per unit for the same item.
A price relative expresses the unit price in each period as a percentage
of the unit price in the base period.
A base period is a given starting point in time.
Price in period t
Price relative in period t = × 100 (1)
Base period price

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Example: Besco Products

Price Relatives The prices Besco paid for newspaper and television ads in
1992 and 1997 are shown below. Using 1992 as the base year, compute a
1997 price index for newspaper and television ad prices.
1992 1997
Newspaper ($) 14794 29412
Television ($) 11469 23904
Newspaper
29, 412
I1997 = × 100 = 199
14, 794
Television
23, 904
I1997 = × 100 = 208
11, 469
Television advertising cost increased at a greater rate.

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Aggregate Price Indexes

An aggregate price index is developed for the specific purpose of

measuring the combined change of a group of items.
An unweighted aggregate price index in period t,denoted by It , is
given by P
Pit
It = P i × 100
i Pi0
where
1 Pit = unit price for item i in period t
2 Pi0 = unit price for item i in the base period

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Laspeyres Price Index and Paasche Price Index

Laspeyres Price Index is computed as follows:

Current Cost of Base Year Basket
L=
Base Year Cost of Basket Year Basket
Paasche Price Index is computed as follows:
Current Cost of Current Year Basket
P=
Base Year Cost of Current Year Basket

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Example: City of Newton

Aggregate Price Indexes Data on energy consumption and expenditures

by sector for the city of Newton are given below. Construct an aggregate
price index for energy expenditures in 2000 using 1985 as the base year.
Sector Quantity (BTU) Unit Price ($/BTU)
1985 2000 1985 2000
Residential 9,473 8,804 $2.12 $10.92
Commercial 5,416 6,015 $1.97 $11.32
Industrial 21,287 17,832 $0.79 $5.13
Transportation 15,293 20,262 $2.32 $6.16

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Example: City of Newton

Unweighted Aggregate Price Index

10.92 + 11.32 + 5.13 + 6.16
I2000 = × 100 = 466
2.12 + 1.97 + 0.79 + 2.32
Weighted Aggregate Index (Laspeyres Method)

10.92(9473) + . . . + 6.16(15293)
I2000 = × 100 = 443
2.12(9473) + . . . + 2.32(15293)

Weighted Aggregate Index (Paasche Method)

10.92(8804) + . . . + 6.16(20262)
I2000 = × 100 = 415
2.12(8804) + . . . + 2.32(20262)

The Paasche value being less than the Laspeyres indicates usage has
increased faster in the lower-priced sectors.

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Consumer Price Index (CPI)

Primary measure of the cost of living in Kenya.

It is defined as a measure of the weighted aggregate change in retail
prices paid by consumers for a given basket of goods and services.
Collection of retail prices for the compilation of the CPI is usually
conducted during the second and third weeks of every month.
Prices of different commodities are collected from selected retail
outlets located in 50 data collection zones.
Out of the 50 data collection zones, 14 are located in Nairobi City
County while 36 are located in other urban areas. Nairobi zones cover
outlets in lower income, middle income and upper income areas.
Published monthly by the Kenya National Bureau of
Statistics(KNBS).

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Producer Price Index (PPI)

Measures the monthly changes in prices in primary markets in Kenya.

Used as a leading indicator of the future trend of consumer prices and
the cost of living.
Covers raw, manufactured, and processed goods at each level of
processing.
Includes the output of manufacturing, agriculture, forestry, fishing,
mining, gas and electricity, and public utilities.
Weighted average of price relatives using the Laspeyres method.

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Dow Jones Averages

Indexes designed to show price trends and movements on the New

York Stock Exchange.
The Dow Jones Industrial Average (DJIA) is based on common stock
prices of 30 industrial firms.
The DJIA is not expressed as a percentage of base-year prices.
Another average is computed for 20 transportation stocks, and
another for 15 utility stocks.

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Deflating a Series by Price Indexes

In order to correctly interpret business activity over time, when it is

expressed in dollar amounts, we should adjust the data for the
price-increase effect.
Removing the price-increase effect from a time series is called
deflating the series.
Deflating actual hourly wages results in real wages or the purchasing
power of wages.

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Example: McNeer Cleaners

Deflating a Series by Price Indexes

McNeer Cleaners, with 46 branch locations, has had the total sales
revenues shown on the next slide for the last five years.
Deflate the sales revenue figures on the basis of 1982-1984 constant
dollars. Is the increase in sales due entirely to the price-increase
effect?

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Example: McNeer Cleaners

Deflating a Series by Price Indexes

Year Total Sales ($1000) CPI

1996 8,446 156.9
1997 9,062 160.5
1998 9,830 163.0
1999 10,724 166.6
2000 11,690 172.6

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Deflating a Series by Price Indexes

Year Sales ($1000) Deflated Annual Change (%)

1996 8,446 (8,446/156.9)(100) = 5,383 –
1997 9,062 (9,062/160.5)(100) = 5,646 +4.9
1998 9,830 (9,830/163.0)(100) = 6,031 +6.8
1999 10,724 (10,724/166.6)(100) = 6,437 +6.7
2000 11,690 (11,690/172.6)(100) = 6,773 +5.2

After adjusting revenue for the price-increase effect, revenue is still

increasing at an average rate of 5.9% per year.

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Price Indexes: Other Considerations

Selection of Items
When the class of items is very large, a representative group (usually
not a random sample) must be used.
The group of items in the aggregate index must be periodically
reviewed and revised if it is not representative of the class of items in
mind.
Selection of a Base Period
As a rule, the base period should not be too far from the current
period.
The base period for most indexes is adjusted periodically to a more
recent period of time.

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Price Indexes: Other Considerations

Quality Changes
A basic assumption of price indexes is that the prices are identified for
the same items each period.
Is a product that has undergone a major quality change the same
product it was?
A substantial quality improvement also may cause an increase in the
price of a product.

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Quantity Indexes

An index that measures changes in quantity levels over time is called

a quantity index.
Probably the best known quantity index is the Index of Industrial
Production.
A weighted aggregate quantity index is computed in much the same
way as a weighted aggregate price index.
A weighted aggregate quantity index for period t is given by
P
Qit wi
It = P × 100
wi Qi0

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