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Week 7 - Chapter 14 Index Numbers (COQTA1-B33)

This document provides an overview of quantitative techniques, specifically index numbers. It defines index numbers and explains that they are used to examine price and quantity changes over time. It discusses simple and composite price indexes and quantity indexes. It explains how to calculate these different types of indexes, including the Laspeyres and Paasche methods for weighting items in a composite index. The document also covers how to interpret index numbers based on whether the value is above or below the base value of 100.

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36 views

Week 7 - Chapter 14 Index Numbers (COQTA1-B33)

This document provides an overview of quantitative techniques, specifically index numbers. It defines index numbers and explains that they are used to examine price and quantity changes over time. It discusses simple and composite price indexes and quantity indexes. It explains how to calculate these different types of indexes, including the Laspeyres and Paasche methods for weighting items in a composite index. The document also covers how to interpret index numbers based on whether the value is above or below the base value of 100.

Uploaded by

KAT? LWANA?
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Quantitative Techniques

[COQTA1-B33]

Eduvos (Pty) Ltd (formerly Pearson Institute of Higher Education) is registered with the Department of Higher Education and Training as a private higher education institution under the
Higher Education Act, 101, of 1997. Registration Certificate number: 2001/HE07/008
Learning Outcomes
1. Define and explain the purpose of index numbers.
2. Describe applications of index numbers in management practice.
3. Develop and interpret indices to measure price changes over time
4. Develop and interpret indices to measure quantity changes over time.
5. Calculate a simple price index and interpret.
6. Understand the weighting method for a basket of related items.
7. Explain the Laspeyres approach to weighting in a composite index.
8. Calculate the Laspeyres (and Paasche) price index using the weighted aggregates method and interpret your
answer.
9. Calculate a simple quantity index and interpret.
10. Calculate the Laspeyres (and Paasche) quantity index and interpret your answer.
Introduction
• Definition: An index number can be a summary measure of the overall change in the
level of activity of a single item or a basket of related items from one period to another.
• They are commonly used to examine price, quantity changes, as well as and business
performance levels over a period.
• The most widely known and used index number globally is the consumer price index,
or inflation indicator (CPI).
• The aim of this index is to measure the general changes in retail prices from month to
month and from year to year.
Introduction (cont.)
• An index number is constructed by dividing the value of an item (or a basket of items)
in the current period by its value in a base period, expressed as a percentage.
How to Interpret an Index Number
• An index number measures the change in percentage from a base period, which has an
index value of 100.
• Index values above 100 show an increase in the level of activity being examined, while
index values below 100 reflect a decrease in activity relative to the base period.
• The extent of the change is shown by the difference between the index number and
the base index of 100.
Classification of Index Numbers
• There are two main categories of index numbers. In each of these categories, an index can be
calculated for either a single item or a basket of related items. The categories are as follows:
• price indexes • quantity indexes

– single price index – single quantity index


– composite quantity index
– composite price index
• Additionally, the following notation is used in the construction of price and quantity index
numbers:
 p0 = base period price

 q0 = base period quantity

 p1 = current period price

 q1 = current period quantity


Price Indexes
• A price index measures the percentage change in price between any two time periods
either for a single item (e.g., car tyres) or a basket of items (e.g., car maintenance
items).
Simple Price Index (Price relative)
• The simple price index is the change in price from a base period to another period
for a single item. It is also referred to as a price relative.

• This relative price change is multiplied by 100 to express it in percentage terms.


Composite Price Index for a Basket of
Items
• A composite price index measures the average price change for a basket of related items
(activities) from one period (the base period) to another period (the current period).

Weighting the basket:


o To calculate a composite index, each item must be weighted according to its importance in the
basket. Importance is determined by the value of each item in the basket (i.e., unit price ×
quantity consumed).
o A composite price index measures only price changes in a basket of related items over time.
Since the quantities consumed can also change over time, it is necessary to hold all quantities
consumed constant.
Composite Price Index for a Basket of
Items (cont.)
Laspeyres vs. Paasche Weighting Method:
o Quantities can be held constant either at base period or current period levels. This
results in two approaches to determining weights:
o The Laspeyres approach holds quantities constant at base period levels.
o The Paasche approach holds quantities constant at current period levels.
o One of these approaches must be adopted when calculating a composite price index.
Unless explicitly stated, the Laspeyres approach to weighting items is usually
assumed.
Composite Price Index for a Basket of
Items (cont.)
• There are two methods to acquire a composite price index once the weighting
method has been decided. They are the Laspeyres or Paasche method.
• Both methods produce the same index value but differ only in their reasoning.
• One of the computational methods is the method of weighted aggregates.
Quantity Indexes
• A quantity index measures the percentage change in consumption level, either for
a single item (e.g., milk) or a basket of items (e.g., hardware tools), from one period
to another.
• The methods of calculation for quantity indexes are like those for price indexes.
• When constructing quantity indexes, it is necessary to hold price levels constant
over time to isolate the effect of quantity (consumption level) changes only.
Single Quantity Index (Quantity Relative)
• For a single item, the change in units consumed from a base period to another
period is found by calculating its quantity relative.

• This relative quantity change is multiplied by 100 to express it in percentage terms.


Single Quantity Index (Quantity Relative)
(cont.)
Composite Quantity Index for a Basket of
Items
• A composite quantity index measures the average consumption (quantity) change for
a basket of related items from one period (the base period) to another period (the
current period).

• It should reflect only consumption changes. As such, prices must be held constant to
monitor quantity changes only.

• The construction of a composite quantity index is like that of a composite price index.
It can be calculated using the weighted aggregates method.
Composite Quantity Index for a Basket of
Items
Weighted Aggregates Method – Composite Quantity Index:
• This method compares the aggregate value of the basket between the current period
and the base period. The composite quantity index will reflect overall consumption
changes while holding prices constant at either the base period (Laspeyres approach)
or current period (Paasche approach).
• The Laspeyres approach holds prices constant in the base period.

• The Paasche approach holds prices constant in the current period.


What Happens Next?
• In the next lesson, we will look at practice questions from Chapter 14.
Thank you, see you in the next class!

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36
Chapter 14: Exercises
Index numbers

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