INDEX NUMBERS (SUMMARY)

1. An index number is a summary measure of the overall change in the level

of activity of a single item or a basket of related items from one time period to
another.
2. 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.

Index number = x100%

3. Price index or Quantity index measures the percentage change in price or
Quantity between any two time periods either for a single item (e.g. car
tyres), or a basket of items (e.g. car maintenance items).
The simple price index or Quantity index is the change in price or quantity
from a base period to another time period for a single item. It is also called a
price relative or Quantity relative

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 EXAMPLE
PRICES AND QUANTITIES SOLD BY A RETAIL SHOP.
ITEM 1995 2000
PRICES(P0) QUANTITY(Q0) PRICES(P1) QUANTITY(Q1)
A 4.75 25 5.90 40
B 9.25 120 10.25 110
C 4.25 60 7.25 70

3.1. Find price relative for item B in 2000, where 1995 is the base year.
𝑷𝟏
𝑷𝒓𝒊𝒄𝒆 𝒓𝒆𝒍𝒂𝒕𝒊𝒗𝒆 = 𝒙𝟏𝟎𝟎%
𝑷𝒐

𝟏𝟎. 𝟐𝟓
= 𝒙𝟏𝟎𝟎%
𝟗. 𝟐𝟓
= 𝟏𝟏𝟎. 𝟖𝟏%
Therefore increase of 10.81%
3.2. Find Quantity relative for item C in 2000 where 1995 is the base year.
𝑸𝟏 𝟕𝟎
𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒓𝒆𝒍𝒂𝒕𝒊𝒗𝒆 = 𝒙𝟏𝟎𝟎% = 𝒙𝟏𝟎𝟎%
𝑸𝒐 𝟔𝟎
= 𝟏𝟏𝟔. 𝟔𝟕% 𝑻𝒉𝒆𝒇𝒐𝒓𝒆 𝒊𝒏𝒄𝒓𝒆𝒂𝒔𝒆 𝒐𝒇 𝟏𝟔. 𝟔𝟕%
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4. A composite price index or composite quantity index measures the
average price or average quantity change for a basket of related items
(activities) from one time period (the base period) to another period (the
current period).
5. Weighting the Basket
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).
6. Laspeyres versus Paasche Weighting Method
Prices or Quantities can be held constant either at base period or current
period levels. This results in two approaches to determining weights.
7. The Laspeyres approach holds prices or quantities constant at base period
levels.
The Paasche approach holds prices or quantities constant at current period
levels.
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8. Constructing a Composite Price or Quantity Index
There are two methods to derive a composite price index or
composite quantity index once the weighting method
(Laspeyres or Paasche) has been decided. Both methods
produce the same index value, but differ only in their
reasoning. The two computational methods are:
-the method of weighted aggregates
-the method of weighted average
EXAMPLE 8.1
Calculate the laspeyrus composite price index for 2000, using
the weighted aggregate of relative method with 1995 as a base
year.

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 PRICES AND QUANTITIES SOLD BY A RETAIL SHOP.
ITEM 1995 2000 Po X Q o P1X Q o
PRICES QUANTITY PRICES QUANTITY
(Po) (Q o) (P1) (Q 1)
A 4.75 25 5.90 40 118.75 147.5
B 9.25 120 10.25 110 1110 1230
C 4.25 60 7.25 70 255 435
1483.75 1812.5

∑ 𝑷𝟏 𝑿𝑸𝟎 𝟏𝟖𝟏𝟐.𝟓
- 𝑳𝑷𝑰 = ∑ 𝑷𝟎 𝑿𝑸𝟎
𝒙𝟏𝟎𝟎% = 𝒙𝟏𝟎𝟎% = 𝟏𝟐𝟐. 𝟏𝟔%.
𝟏𝟒𝟖𝟑.𝟕𝟓

Therefore increases of 22.16%.

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 EXAMPLE 8.2
Calculate the Paasche composite price index for 2000, using the
weighted average of relative method with 1995 as a base year.

PRICES AND QUANTITIES SOLD BY A RETAIL SHOP.

ITEM 1995 2000 𝒑𝟏 P0x Q1 𝒑
( 𝟏 )𝒙𝟏𝟎𝟎𝒙(𝒑𝟎 𝒙𝒒𝟏 )
𝒙𝟏𝟎𝟎 𝒑𝟎
𝒑𝟎
PRICES QUANTITY PRICES QUANTITY
(P0) (Q0) (P1) (Q1)

A 4.75 25 5.90 40 124.21 190 23599.9

B 9.25 120 10.25 110 110.81 1017.5 112749.175
C 4.25 60 7.25 70 170.59 297.5 50750.525
405.61 1505 187099.6

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 𝒑𝟏
∑( )𝒙𝟏𝟎𝟎𝒙(𝒑𝟎 𝒙𝒒𝟏 ) 𝟏𝟖𝟕𝟎𝟗𝟗. 𝟔
𝒑𝟎
𝑷𝑷𝑰 = = = 𝟏𝟐𝟒. 𝟑𝟐%
∑(𝒑𝟎 𝒙𝒒𝟏 ) 𝟏𝟓𝟎𝟓
Therefore increase of 24.32%.

EXAMPLE 8.3
Calculate the Paashe composite quantity index for 2000, using
the weighted aggregate of relative method with 1995 as a base
year.

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PRICES AND QUANTITIES SOLD BY A RETAIL SHOP.
ITEM 1995 2000 P1 X Q1 P1X Q0
PRICES QUANTITY PRICES QUANTITY
(P0) (Q0) (P1) (Q1)

A 4.75 25 5.90 40 236 147.5

B 9.25 120 10.25 110 1127.5 1230
C 4.25 60 7.25 70 507.5 435
1871 1812.5

∑ 𝑷𝟏 𝑿𝑸𝟏 𝟏𝟖𝟕𝟏
- 𝑷𝑸𝑰 = ∑ 𝒙𝟏𝟎𝟎% = 𝒙𝟏𝟎𝟎% = 𝟏𝟎𝟑. 𝟐𝟑%.
𝑷𝟏 𝑿𝑸𝟎 𝟏𝟖𝟏𝟐.𝟓

- Therefore increases of 3.23%.

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 Now, let’s apply the following information:
- Laspeyrus approach – prices or quantities are held constant at
base period levels.
- Paasche approach – prices or quantities are held constant at
current period levels.

PRICES AND QUANTITIES SOLD BY A RETAIL SHOP.

ITEM 1995 2000
PRICES(P0) QUANTITY(Q0) PRICES(P1) QUANTITY(Q1)
A 4.75 25 5.90 40
B 9.25 120 10.25 110
C 4.25 60 7.25 70

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8.4. Calculate the composite quantity index for 2000, using the
weighted average method with 1995=100, if prices are held constant
at 2000 (current period) levels.
𝒒
∑( 𝟏)𝒙𝟏𝟎𝟎𝒙(𝒑𝟏 𝒙𝒒𝟎 )
𝒒𝟎
Answer: USE 𝑷𝑸𝑰 = ∑(𝒑𝟏 𝒙𝒒𝟎 )
because prices are held
constant at current period levels

8.5 Calculate the composite quantity index for 2000, using the
weighted average method with 1995=100, if prices are held constant
at 1995(base period) levels.
𝒒
∑( 𝟏)𝒙𝟏𝟎𝟎𝒙(𝒑𝟎 𝒙𝒒𝟎 )
𝒒𝟎
Answer: USE 𝑳𝑸𝑰 = ∑(𝒑𝟎 𝒙𝒒𝟎 )
because prices are held
constant at base period levels.

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ADDITIONAL TOPIC OF INDEX NUMBERS
CHANGING THE BASE OF AN INDEX SERIES
The base of an index number series can be shifted from one time period to another to
make the interpretation of recent values of the index number series more meaningful.
To re-base an index number series to a new base period, k, multiply each index
number in the series by the following adjustment factor:
100
𝐴𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑛𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 =
𝑖𝑛𝑑𝑒𝑒𝑥 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑘
EXAMPLE
For data below, make year 2000 your new base year index.

YEAR 1990 1995 2000 2005 2010

PRICES 7.05 8.10 9.05 10.15 11.00
Price relative 77.90 89.50 100 112.15 121.55

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 100 100
𝐴𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑛𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 = = = 11.0497
𝑖𝑛𝑑𝑒𝑥 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑘 9.05

Now multiple all prices by the adjustment factor.

1990: 7.05x11.0497= 77.90

1995: 8.10x11.0497=89.50
2000: 9.05x11.0497=100
2005: 10.15x11.0497=112.15
2010: 11x11.0497=121.55

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Link relatives
Link relatives are indexes that reflect price or quantity changes on a period-by-period
basis
pi
Pr ice _ link _ relative   100%
pi 1

qi
Quantity _ link _ relative   100%
qi 1

EXAMPLE
For below data calculate link relative.
YEAR 1990 1995 2000 2005 2010
PRICES 7.05 8.10 9.05 10.15 11.00
Link _ 114.89 111.73 121.21 108.37
relative 𝟖.𝟏𝟎 𝟗.𝟎𝟓 𝟏𝟏
=( 𝒙𝟏𝟎𝟎) =( 𝒙𝟏𝟎𝟎) =( 𝒙𝟏𝟎𝟎)
𝟕.𝟎𝟓 𝟖.𝟏𝟎 𝟏𝟎.𝟏𝟓

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Notice:
𝒑𝒊 𝟏𝟎.𝟏𝟓
Price Link relative for 2005= 𝒙𝟏𝟎𝟎% = 𝒙𝟏𝟎𝟎% = 𝟏𝟐𝟏. 𝟐𝟏
𝒑𝒊−𝟏 𝟗.𝟎𝟓
𝒑𝒊 𝟏𝟏
Price Link relative for 2010=𝒑 𝒙𝟏𝟎𝟎% = 𝟏𝟎.𝟏𝟓 𝒙𝟏𝟎𝟎% = 𝟏𝟎𝟖. 𝟑𝟕
𝒊−𝟏

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