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Chapter

Eighteen

McGraw- 2005 The McGraw-Hill Companies, Inc., All


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Chapter Eighteen
Index Numbers
GOALS
When you have completed this chapter, you
will be able to:
ONE
Describe the term index.
TWO
Understand the difference between a weighted price index and
an unweighted price index.
THREE
Construct and interpret a Laspeyres Price index.
FOUR
Construct and interpret a Paasche Price index. Goals
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Chapter Eighteen continued

Index Numbers
GOALS
When you have completed this chapter, you
will be able to:
FIVE
Construct and interpret a Value Index.
SIX
Explain how the Consumer Price index is constructed and
interpreted.

Goals
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An Index Number
expresses the relative
change in price,
quantity, or value
compared to a base
period.

A Simple Index Number


measures the relative change in
just one variable.
Index Numbers
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Mr. Wagner
owns stock in
three companies.
Given is the
price per share
at the end of
1997 and 2002
for the three
stocks and the
Simple indexes using 1997 as
quantities he
owned in 1997 base year (1997=100)
and 2002. Price Share
($2/$1)(100)=200 (50/30)(100)=167
($4/$5)(100)=80 (30/15)(100)=200
($6/$6)(100)=100 (20/40)(100)=50
Example 1
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Easier to Indexes Why
comprehend compute
than actual indexes?
numbers
$ 3 4 5 ,6 5 1 ,2 8 9 ,5 6 0
(percent
change) or 10% ?

Provide convenient
Facilitate ways to express the
comparison of change in the total
unlike series of a heterogeneous
group of items CPI
Bread $0.89

Car $18,000
Dress $200
Surgery $400,000
Why Convert Data to Indexes?
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Indexes: Four classifications
Quantity
Price Measures the changes in
quantity consumed from
Measures the changes
the base period to
in prices from a
another period.
selected base period
to another period. Special purpose
Combines and weights a
Value heterogeneous group of series
Measures the change in the to arrive at an overall index
value of one or more items showing the change in
from the base period to the business activity from the
given period (PxQ). base period to the present.
Types of Index Numbers
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Price Index Producer Price Index - measures the


average change in prices received in
the primary markets of the US by
producers of commodities in all
stages of processing (1982=100).

Quantity

Federal Reserve
Quantity Output

Price and Quantity Indexes


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Value

Special purpose

Value and Special Purpose Indexes


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Simple Price Index, P From Example 1 a simple


aggregate price index for
pt the three stocks
P (100)
p0
pt
where P (100)
p 0
po the base period price
$2 $5 $6
pt the price at the selected (100)
$1 $5 $6
or given period. 100.0

Construction of Index Numbers


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Weighted index Considers both the price and


the quantities of items
Tends to overweight goods whose prices have increased
Laspeyres Weighted Price Index, P
Two methods of Uses the base period quantities as
computing the weights
price index
pt q0
Laspeyres method P (100)
Paasche method where
p0q0
pt is the current price
p0 is the price in the base period
q0 is the quantity consumed in the base
period
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Paasche Weighted Price Index, P
Present year weights Tends to overweight
substituted for the original goods whose prices have
base period weights gone down

pt qt
P (100)
p0qt
where
qt is the current quantity consumed
p0 is the price in the base period
pt is the current price.
Construction of Index Numbers
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Fishers Ideal Index


Fishers ideal index = (Laspeyres index)(Paasches index)

The geometric Balances the negative


mean of Laspeyres effects of the
and Paasche Laspeyres and
indexes Paasches indices.

Requires that a new set of


quantities be determined
each year. Fishers Ideal Index
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Value Index

Reflects changes in both price and quantity

Both the price and quantity change


from the base period to the given period

pt qt
V (100)
p0q0

Value Index
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In 1978 two Millions of employees


consumer price in automobile, steel,
indexes were and other industries
published. One have their wages
was designed for adjusted upward when
urban wage the CPI increases.
earners and
clerical workers.
It covers about one third of the
population. Another was
designed for all urban
households. It covers about
80% of the population.
Consumer Price Index
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Usefulness of CPI
It allows consumers to
determine the effect of
price increases on their
purchasing power.
It is an economic
It is a It computes
indicator of the
yardstick for real income:
rate of inflation in
revising real income
the United States.
wages, = money
pensions, income/CPI
alimony (100)
payments, etc. Consumer Price Index
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Deflating Sales

Actual sales
Deflated sales (100)
An approximate index

Determining the purchasing power of the dollar


compared with its value for the base period
$1
Purcha sin g power of dollar (100)
CPI

Consumer Price Index


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Shifting the base


101 115 When two or more series
of index numbers are to be
compared,they may not 101 115
have the same base period.
First select a common base period for all series.

Then use the respective base numbers as the denominators


and convert each series to the new base period.

Consumer Price Index


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Mr. Wagner
owns stock in
three companies.
Shown below is
the price per
share at the end
of 1997 and Laspeyres Weighted Price Index, P
2002 for the p t q 0
three stocks and P (100)
p 0 q 0
the quantities he $2(30) $4(15) $6(40)
owned in 1997 (100)
$1(30) $5(15) $6(40)
and 2002. $360
(100) 104.35
$345
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Paasche Weighted Price Index, P
p t q t
P (100)
p 0 q t
$2(50) $4(30) $6(20)
(100)
$1(50) $5(30) $6(20) Value Index
$340 p t q t
(100) 106.25 P (100)
$320 p 0 q 0
$2(50) $4(30) $6(20)
Fishers Ideal Index (100)
$1(30) $5(15) $6(40)


F = (104.35)(106.25)
$340
$345
(100) 98.55
=105.3
Example 1 continued

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