Index Numbers

We shall cover:
 Price and Quantity indices
 Time series of relatives
 Rebasing index numbers
 Composite Index numbers-Laspeyre,
Paasche and Fisher
 Index Numbers
 Index Number is a statistical
measure designed to show changes
in a variable or group of related
variables with respect to time,
geographic location, income,
profession etc.
 A collection of index numbers for
different years, locations etc is
sometimes called an index series
Index Numbers

 An index number measures the

relative change in price, quantity,
value, or some other item of
interest from one time period to
another.
 A simple index number measures
the relative change in just one
variable.
 Application of Index Numbers
 Using Index numbers we can compare food or
other living costs in a city during one year with
those of a previous year.
 We can also compare gold production during a
given year in one part of the country e.g
Karamoja with that in another part such as
Mubende.
 We can use index numbers to compare
intelligence of students in different Universities
or for different years.
 Index Numbers

 Index numbers allow relative comparisons

over time
 Index numbers are reported relative to a Base
Period Index

 Base period index = 100 by definition

 Used for an individual item or measurement
 Single Item Price Index or Relative
Consider observations over time on the price of a single
item
 To form a price index, one time period is chosen as a
base, and the price for every period is expressed as a
percentage of the base period price
 Let p0 denote the price in the base or reference period
 Let p1 be the price in a second or given period
 The price index for this second or given period is

 p1 
100 
 p0 
 Price Relatives

 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)
Base period price

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 Example: KYU Products

 Price Relatives
The prices KYU paid for newspaper and television
adverts in 1992 and 1997 are shown below. Using 1992
as the base year, compute a 1997 price index for
newspaper and television advert prices.

1992 1997
Newspaper shs14,794 shs 29,412
Television shs11,469 shs 23,904

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 Example: Besco Products

 Price Relatives
Newspaper Television
29,412 23,904
I1997  (100)  199 I1997  (100)  208
14,794 11,469
Television advertising cost increased at a greater rate.

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 Index Numbers: Example
 Airplane ticket prices from 1995 to 2003:
Index
Year Price (base year
= 2000)
1995 272 85.0 P1996 288
1996 288 90.0 I1996  100  (100)  90
P2000 320
1997 295 92.2
1998 311 97.2
Base Year:
1999 322 100.6 P2000 320
2000 320 100.0 I2000  100  (100)  100
P2000 320
2001 348 108.8
2002 366 114.4
P2003 384
2003 384 120.0 I2003  100  (100)  120
P2000 320
 Index Numbers: Interpretation
 Prices in 1996 were 90%
P1996 288
I1996   100  (100)  90 of base year prices ie
P2000 320
decreased by 10%

P2000 320  Prices in 2000 were 100%

I2000   100  (100)  100
P2000 320 of base year prices (by
definition, since 2000 is the
base year)

P2003 384
I2003   100  (100)  120  Prices in 2003 were 120%
P2000 320 of base year prices ie
increased by 20%
 Properties of Price Relatives
 Identity Property-The price relative for a given
period with respect to the same period is 1 or 100%
 Time Reversal Property-If two periods are
interchanged, the corresponding price relatives are
reciprocals of each other Pa|bPb|a=1
 or Pa|b = 1
 Pb|a
 Cyclical or Circular Property Pa|bPb|cPc|a=1
 Pa|bPb|cPc|aPd|a=1 etc
 Aggregate Price Indexes
 An aggregate index is used to measure the rate
of change from a base period for a group of items

Aggregate
Price Indexes

Unweighted Weighted
aggregate aggregate
price index price indexes

Laspeyres Index
 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

 Pit
It  (100)
 Pi 0

where
Pit = unit price for item i in period t
Pi 0 = unit price for item i in the base period

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 Aggregate Price Indexes

 With a weighted aggregate index each item in the

group is weighted according to its importance, which
typically is the quantity of usage.
 Letting Qi = quantity for item i, the weighted
aggregate price index in period t is given by

 Pit Q i
It  (100)
 Pi 0 Q i

where the sums are over all items in the group.

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 Aggregate Price Indexes

 When the fixed quantity weights are determined

from the base-year usage, the index is called a
Laspeyres index.

 When the weights are based on period t usage the

index is a Paasche index.

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 Example: City of Washington

 Aggregate Price Indexes

Data on energy consumption and expenditures by
sector for the city of Washington are given below.
Construct an aggregate price index for energy
expenditures in 2000 using 1985 as the base year.

Quantity (BTU) Unit Price ($/BTU)

Sector 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 .79 5.13
Transport. 15,293 20,262 2.32 6.16

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 Example: City of Washington

 Unweighted Aggregate Price Index

I2000 = 10.92 + 11.32 + 5.13 + 6.16 (100) = 466
2.12 + 1.97 + .79 + 2.32
 Weighted Aggregate Index (Laspeyres Method)
I2000 = 10.92(9473) + . . . + 6.16(15293) (100) = 443
2.12(9473) + . . . + 2.32(15293)
 Weighted Aggregate Index (Paasche Method)
I2000 = 10.92(8804) + . . . + 6.16(20262) (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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A. Aggregative Method

Example : With the help of following data .Calculate index number for 2010 taking
2006 as base year.

commodity Price in Price in

2006(Rs.) 2010(Rs.)
A 100 145
B 90 130
C 145 200
D 180 275
E 85 150
 Solution:

commodity Price in Price in

2006(Rs.)(Po) 2010(Rs.)(P1)
A 100 145
B 90 130
C 145 200
D 180 275
E 85 150
∑Po =600 ∑P1 = 900
Solution:

∑P1
____
Po1 = X 100
∑Po

900
____
Po1 = X 100
600

900
____
=
6

=150

It means that there is a net increase of 50% in the price of commodities in 2010
compared to the price of 2006
 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
 Qit w i
It  (100)
 Qi0 w i

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 Unweighted
Aggregate Price Index
 Unweighted aggregate price index for period
t for a group of K items:
i = item
 K 
  ti 
p t = time period
100 iK1  K = total number of items
 
  p0i 
 i1 
K

p
i1
ti = sum of the prices for the group of items at time t
K

p
i1
0i = sum of the prices for the group of items in time period 0
 Unweighted Aggregate Price
Index: Example
Automobile Expenses:
Monthly Amounts ($):
Index
Year Lease payment Fuel Repair Total (2001=100)
2001 260 45 40 345 100.0
2002 280 60 40 380 110.1
2003 305 55 45 405 117.4
2004 310 50 50 410 118.8

I2004  100
 P
2004
 (100)
410
 118.8
P2001 345
 Unweighted total expenses were 18.8%
higher in 2004 than in 2001
 Weighted
Aggregate Price Indexes
 A weighted index weights the individual prices by
some measure of the quantity sold
 If the weights are based on base period quantities the
index is called a Laspeyres price index
 The Laspeyres price index for period t is the total cost of
purchasing the quantities traded in the base period at prices in
period t , expressed as a percentage of the total cost of
purchasing these same quantities in the base period
 The Laspeyres quantity index for period t is the total cost of the
quantities traded in period t , based on the base period prices,
expressed as a percentage of the total cost of the base period
quantities
 Laspeyres Price Index
 Laspeyres price index for time period t:
 K 
  q0ip ti 
100 iK1 
 
  q0ip 0i 
 i1 
q0i = quantity of item i purchased in period 0

p0i = price of item i in time period 0

p ti = price of item i in period t
 Laspeyres Quantity/Volume
Index
 Laspeyres quantity index for time period t:
 K

  qtip 0i 
100 iK1 
 
  q0ip 0i 
 i1 
p0i = price of item i in period 0

q0i = quantity of item i in time period 0

qti = quantity of item i in period t
 Calculating a Seasonal Index
Centered Ratio-to-
Moving Moving
Quarter Sales Average Average

1 23
2 40 x3 25
100 *  (100)  83.7
3 25 29.88 83.7 x3 29.88
4 27 32.00 84.4
5 32 34.00 94.1
6 48 36.25 132.4
7 33 38.13 86.5
8 37 39.00 94.9
9 37 40.13 92.2
10 50 etc… etc…
11 40 … …
… … … …
 Calculating Seasonal Indexes
(continued)
Centered Ratio-to-
Moving Moving
Quarter Sales Average Average

1 23
Fall 2 40 1. Find the median
3 25 29.88 83.7 of all of the
4 27 32.00 84.4
same-season
5 32 34.00 94.1
6 48 36.25 132.4 values
Fall 2. Adjust so that
7 33 38.13 86.5
8 37 39.00 94.9 the average over
9 37 40.13 92.2 all seasons is
10 50 etc… etc…
Fall 100
11 40 … …
… … … …
 Interpreting Seasonal Indexes
 Suppose we get these
seasonal indexes:
Seasonal  Interpretation:
Season
Index
Spring sales average 82.5% of the
Spring 0.825 annual average sales

Summer 1.310 Summer sales are 31.0% higher

than the annual average sales
Fall 0.920 etc…

Winter 0.945
 = 4.000 -- four seasons, so must sum to 4
 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.
Value relative= Price relative x Quantity relative

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