Scribd
Upload
0 views

Lecture 3

Index numbers are statistical measures that show changes in variables over time or other characteristics, commonly used to compare economic performance, prices, or production to a base value. Examples include price indexes like the Consumer Price Index (CPI), stock market indexes, and production indexes, which help quantify changes in costs and outputs. The document also discusses methods for constructing and using weighted and unweighted indexes to analyze data trends effectively.

Uploaded by

Shouvik Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
0 views

Lecture 3

Index numbers are statistical measures that show changes in variables over time or other characteristics, commonly used to compare economic performance, prices, or production to a base value. Examples include price indexes like the Consumer Price Index (CPI), stock market indexes, and production indexes, which help quantify changes in costs and outputs. The document also discusses methods for constructing and using weighted and unweighted indexes to analyze data trends effectively.

Uploaded by

Shouvik Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 34

Index Numbers

Index numbers are statistical measures designed to show


changes in a variable or group of variables with respect to
time, geographic location, or other characteristics. They are
often used to compare the level of some activity, such as
economic performance, prices, or production, to a base value
set at 100.
Price Indexes: These measure the average change over time in
the prices paid by urban consumers for a market basket of
consumer goods and services. The Consumer Price Index (CPI) is
a well-known example, indicating the inflation rate and cost of
living changes.

Stock Market Indexes: These reflect the performance of a


specific set of stocks, representing a portion of the overall
market.

Production Indexes: These measure changes in the volume of


production or economic output in various sectors, such as
manufacturing, mining, and utilities. An example is the
Industrial Production Index.

Quantity Indexes: Similar to production indexes, these measure


changes in the quantity of goods produced or sold, often used
in economic analysis to assess sectoral performance over time.
Let's create a simple example to illustrate
how a price index works, focusing on the
Consumer Price Index (CPI), which
measures the average change over time
in the prices paid by consumers for a
basket of goods and services.

Scenario:
• Imagine we are tracking the price
changes of a simplified basket of goods
over two years to calculate the CPI. Our
basket includes only three items: bread,
milk, and eggs. The base year for our
index will be Year 1.
Total cost of the basket in Year 2 = $2.10 + $3.20 + $1.60 = $6.90
The CPI for Year 2 is calculated to be approximately 106.15. This means that the cost of the
basket of goods has increased by about 6.15% from Year 1 to Year 2. The CPI in this simplified
example gives us a way to quantify inflation for these specific goods over the period of a
year.
Simple Index Numbers

INDEX NUMBER: A number that expresses the


relative change in price, quantity, or value
compared to a base period.

If the index number is used to measure the relative


change in just one variable, such as hourly wages in
manufacturing, we refer to this as a simple index.
Why convert data to indexes?

• An index is a convenient way to express a change in a


diverse group of items.

• The Consumer Price Index (CPI), for example, encompasses


200 categories of items summarized by eight groups—food
and beverages, housing, apparel, transportation, medical care,
recreation, education and communication, and other goods
and services. The prices of 80,000 goods and services in the
200 categories are collected. Prices are expressed in many
different units such as dollars per pound or a dozen eggs. Only
by summarizing these prices with an index number can the
federal government and others concerned with inflation keep
informed of the overall movement of consumer prices.

• Converting data to indexes also makes it easier to assess the


trend in a series composed of exceptionally large numbers.
Construction of Index Numbers

The price in a selected year is divided by the price in the base year. The base-period
price is designated as p0, and a price other than the base period is often referred to as
the given period or selected period and designated pt . To calculate the simple price
index P using 100 as the base value for any given period.
• The base period need not be a single year. Note
in Table that if we use 2015–2016 = 100, the base
price for the stapler would be $21 [found by
determining the mean price of 2015 and 2016,
($20 + $22)/2 = $21]. The prices $20, $22, and $23
are averaged if 2015–2017 is selected as the base.
The mean price would be $21.67.
• The indexes constructed using the three
different base periods are presented in Table .
(Note that when 2015–2017 = 100, the index
numbers for 2015, 2016, and 2017 average 100.0,
as we would expect.)
• Logically, the index numbers for 2018 using the
three different bases are not the same.
Unweighted Indexes

In many situations, we wish to combine


several items and develop an index to
compare the cost of this aggregation of items
in two different time periods. For example, we
might be interested in an index for items that
relate to the expense of operating and
maintaining an automobile. The items in the
index might include tires, oil changes, and
gasoline prices.
Or we might be interested in a college student
index. This index might include the cost of
books, tuition, housing, meals, and
entertainment. There are several ways we can
combine the items to determine the index.
Simple Average of the Price Indexes and Simple Aggregate Index

We would like to develop an index for this group of food items for 2019, using
the 2009 prices as the base.
This indicates that the mean price of the group of food items decreased 1.5% from 2009
to 2019.
Weighted Indexes
Two methods of computing a weighted price index are the Laspeyres
method and the Paasche method. They differ only in the period used
for weighting. The Laspeyres method uses base-period weights; that is,
the original prices and quantities of the purchased items are used to
find the percent change over a period of time in either price or
quantity consumed, depending on the problem. The Paasche method
uses current-year weights.
where:
• P is the price index.
• Pt is the current price.
• p0 is the price in the base period.
• q0 is the quantity used in the base period.

Laspeyres
Price Index
Exercise -
The prices for the six
food items and the units
consumed by a family in
2009 and 2019 are
shown in the table.
Paasche Price Index

The Paasche index is an alternative. The procedure is similar, but instead of


using base-period quantities as weights, we use current-period quantities as
weights.
Fisher’s Ideal Index

As noted earlier, Laspeyres’ index tends to overweight goods whose prices have increased.
Paasche’s index, on the other hand, tends to overweight goods whose prices have decreased.
In an attempt to offset these shortcomings, Irving Fisher, in his book “The Making of Index
Numbers”, published in 1922, proposed an index called Fisher’s ideal index.

Fisher’s index seems to be theoretically ideal because it combines the best features of the
Laspeyres and Paasche indexes. That is, it balances the effects of the two indexes.
Determine Fisher’s ideal index for
Value Index
To put it another way, the value of apparel sales increased 17.8% from May
2015 to May 2019.
In addition to measuring changes in the
prices of goods and services, both
consumer price indexes have a number
of other applications.
Special Uses of the The CPI is used to determine real
disposable personal income, to deflate
Consumer Price Index sales or other variables, to find the
purchasing power of the dollar, and to
establish cost-of-living increases. We
first discuss the use of the CPI in
determining real income.
The concept of real income is sometimes called deflated income,
and the CPI is called the deflator.
End of Chapter

You might also like