[AP MACROECONOMICS~-Ippalt 20/4 How to Calculate a Price Index “pric index is used fo measuring ie rae f price increases La, lation). The two most common price indies used Ta [AP Economics are the consumer pre index (CPI) andthe GDP Deflator. “There is more than one method for constructing a price index. ‘The easiest method isthe weighted-average method which uses fined quanity market basket of goods priced in different years. Step#1: Compute the total cost ofthe market basket foreach year Step #2: Pick a Base Year (The base year index will always = 100) Step#3: Compare the total cost ofeach year to the cost of the base year to calevlate each rice index: Index Number = Current-vearcost X 100 Base-year cost 1) Please ill in all blanks ($_) in the table below to help you construct a price index. Year 1 2000) ‘Year? 2008) __Year3_ 2006) Market Basket ems # of Units $ perunit Total ost _Sperunit Total Cost _ § por unit Total Cost Cheese zis |sizs_ $350 |s1s0 _g300" |siso say | Blue Jeans 2pnirs__|si200_es240 |sisso 300 | s20.00 50.0 | Gasoline 1ozallons | si25 $1280 | si.60 860" | $270 s2m0r {tata Costormastety| — ‘Year 1 Index: “(S4O/S40) x:100=1001NdEX Chase y Year? Index = _ (850/840) x 100 = 125 index ‘Year3 Index= --(S70/840)XT00=17S index 3) Calculate the inflation rate ona percentage bass forthe following: ‘a. Hint: formula = (Ending index ~ Beginning index) Beginning Index} X_ 100 1. Forexample:ifa stock price rose fom $6 to $8 share the % gain is [8-66] X 100=+33% Your Ito Yeor2: SURS==LONN00=25:00%0 Yeor1t0Yeor3: — (U7S=A00)/100=78i0%8" Yertover: — gassinéngacsaneerTETHER Vear | to be our base year. To determine if our choice of base year influenced the results t's use Year 2a our base year and recompute both the index numbers andthe percentage changes between the years. The First percentage change in prices has been done for you. (Change the Base Year of a Price Index: Index Numbers Percentage Change in Prices Year (ear 2 = Base) (caleuatd by sing changes in inde mumbre) Year 1 [ GHRS50) x 100 = 80 Between Ye. tand V2 | ((100—B0)ROX TOO 25% Year? | GSUBSI)x 100= 100 Bewern Fre | QO NOOVITOO=AOIO% Geran YS [CREDITS [RTETRCTT (AOSD STROM '5) Dot index members change when the hase year is changed fom Year I 10 Year2? YES! 16) Does the percentage change in prices besween the years change wea the based is change fom Year Ito Year 22 NO! explain why: PICKING A BASE ONLY CHANGES THE INDEX #°S INFLATION NEVER CHANGES BETWEEN YEARS BASED ON BASE YEAR" 7) Would he pried index umbers change iyouchoe affront set of expenditures paters were selected fr weighting for the market bsket? (he. fou charged he mate up of he marke ask) YES! eapisinwiy; MARKET BASKET COMPOSITION & WEIGHTING _ MATTER. If you inerease the % of computers in a basket => inflation is, different... 8) Would your ination calculations be accurate ifthe quality af goods in your marke basket changed over the ears? {asrame no adjusient for quay) 9) Whatisa COLA: coSF OF living adjustments: 10) Would COLA based ona price index be assure for you i you spent money éiferely tan the make ake weightings? ‘Tent, would tbe fo high orto ow?