What is the Paasche Price Index?

The Paasche Price Index is a consumer price index used to measure the

change in the price and quantity of a basket of goods and services
relative to a base year price and observation year quantity. Developed
by German economist Hermann Paasche, the Paasche Price Index is
commonly referred to as the “current weighted index.”

Understanding the Paasche Price Index

The Paasche Price Index is a price index used to measure the general
price level and cost of living in the economy and calculate inflation. The
index commonly uses a base year of 100, with periods of higher price
levels shown by an index greater than 100 and periods of lower price
levels by indexes lower than 100.

The Paasche Price Index is commonly confused with the Laspeyres

Price Index. The main differentiator between the Paasche Index and the
Laspeyres Price Index is that the former uses current-period quantity
weightings while the latter uses base-period quantity weightings.

Formula for the Paasche Price Index

The formula for the index is as follows:

Where:
  Pi,0 is the price of the individual item at the base period,
and Pi,t is the price of the individual item at the observation
period.
 Qi,t is the quantity of the individual item at the observation
period.

Although the mathematical equation for the Paasche Price Index seems
confusing, the numerator is simply the total expenditure for all items at
the observation period using current observation period quantities and
prices, while the denominator is the total expenditure for all items at
the base period using current observation period quantities and base
period prices. Therefore, the index can be more easily understood
when rewritten as follows:

Example

The following information regarding the change in the prices and

quantities of each individual good in a hypothetical economy is
provided. Determine the Paasche Price Index for Year 0, Year 1, and
Year 2, using Year 0 as the base year.

  Item   Year 0   Year 1   Year 2

Good A     $5     $6      $7

Good B    $10     $11     $13

Good C    $20     $22     $24

 

  Item   Year 0   Year 1   Year 2

Good A      50      55      57

Good B      60      65      67

Good C      70      75      77

Using the formula for the Paasche Price Index:

Therefore, the price index using the Paasche Price Index is as follows
for each year:

 Year 0 (Base Year) = 100

 Year 1 = 111.13
 Year 2 = 124.97

Note that in the Paasche Price Index, the prices are the only items that
change. We are comparing the current year (observation year) prices to
the base year prices at the same quantities.
 

Advantages and Disadvantages of the Paasche Price Index

The advantages of the index include:

 Takes into consideration consumption patterns by using current

quantities (current weightings)
 Is not upward-biased in terms of price increases (compared to the
Laspeyres Price Index)

The disadvantages of the index include:

 Data on current weightings (i.e., quantities for each item) can be

difficult to obtain
 Costlier than using a Laspeyres Price Index
 Tends to understate the changes in price because the index
already reflects changes in consumption patterns when
consumers respond to price changes

Key Takeaways

The Paasche Price Index is a price index used to measure the change in
the prices and quantities of a basket of goods and services relative to a
specified base period price. The numerator of the index is the total
expenditures of all items at the observation period using the
observation period price and quantities, while the denominator is the
total expenditures of all items using base period prices and observation
period quantities.

The index corrects for the upward price bias of the Laspeyres Price
Index and also takes into consideration consumption patterns.
However, it relies on current data (which may not be readily available)
and tends to understate the changes in price.