Constructing Price Index

& Calculating Rate of

Inflation
Unit 10 - Lesson 5

Learning outcomes:
Construct a weighted price index using a set
of data provided.
Calculate the inflation rate from a set of data.
Calculate Real Income
Compare and contrast CPI and GDP deflator

Weighted Price Index

Price index that weights
the various goods &
services consumers
consume according to the
importance to the
consumer.
http://www.singstat.gov.
sg/images/default-source/defaultalbum/cpi2014basket.gif

Steps:
1. Decide on a base year.
2. Use the price (base year), to calculate the base year value of
the basket of goods. (Price X Quantity)
3. Add up the value of all goods & services in the basket for the
base year.
4. Holding the quantity constant to the base year, multiply each
subsequent years price by the base year quantity.
5. Add up the goods in the basket for each year. Quantity (base
year) X Price (year) for all goods.

Example:
Good/Service

Quantity
in Basket

Price per
unit 2010

Price per
unit 2011

Price per
unit 2012

Price per
unit 2013

Pizzas

25

DVDs

15

17

18

18

Bus Rides

47

Step 1: Base Year 2010

Step 2: Pizza: 25 x 7 = $175
DVDs: 9 x 15 = $135
Bus Rides: 47 x 2 = $94

Good/Service

Quantity in
Basket

Price per unit

2010

Price per unit

2011

Price per unit

2012

Price per unit

2013

Pizzas

25

DVDs

15

17

18

18

Bus Rides

47

Step 3:
(2010) $175 + $135 + $94 = $404
Step 4 & 5:
Base year quantity x Price (current year)
Pizzas

(2011)
25 x 6 = $150

(2012)
25 x 7 = $175

(2013)
25 x 6 = $150

DVDs

9 x 17 = $153

9 x 18 = $162

9 x 18 = $162

Bus Rides

47 x 4 = $188

47 x 4 = $188

47 x 3 = $141

Total (Step 5)

$491

$525

$453

Constructing the Price Index

All information necessary to construct the price
index is on the previous page.
Price Index:
Value of Basket in Specific Year

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Base year

xs 100

Price Index Calculation

Price Index:
Value of Basket in Specific Year

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Base year
2010:
2011:
2012:
2013:

404 divided by 404

491 divided by 404
525 divided by 404
453 divided by 404

xs 100
=
=
=
=

100.0
121.5
129.0
112

Calculating Inflation
% change = new - old
-------------------------------------------------------------

old

xs 100

2010 - 2011: 121.5 - 100 divided by 100 = 21.5%

2011 - 2012: 129 - 121.5 divided by 121.5 = 6.1%
2012 - 2013: 112 - 129 divided by 129 =
-13%

Interpretation
2010 - 2011: 21.5%
2011 - 2012: 6.1%
2012 - 2013: -13%

Inflation
Disinflation
Deflation

Indexes with:
Increasing values over time represent inflation
Increasing values less than the previous year represent
disinflation
Decreasing values over time represent deflation

Calculating Real Income

Real Income can be calculated from using the
CPI for consumers, pensioners, or other social
groups.
Real Income = Nominal Income
__________________________________________________________________________

CPI

Xs 100

Comparing CPI & GDP Deflator

CPI: based on a fixed basket of goods &
services.
GDP Deflator: actual output produced over time
valued at a fixed base year price.
CPI based on consumption
GDP Deflator based on production

Further comparisons:
1. GDP deflator includes irrelevant goods based
on consumers.
2. Excludes exports.
3. GDP deflator does not allow goods & services to
be weighted based on the importance to
consumers.