MATHEMATICS OF FINANCE AND APPLICATIONS

G.B.S

...

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 1 / 14

 Lecture 1: Percentages and Index numbers

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Objectives

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Percentages: A brief review

(a) A …rm’s annual sales rise from 50 000 to 55 000 from one year to the
next. Express the rise as a percentage of the original.
(b) The government imposes a 15% tax on the price of a good. How
much does the consumer pay for a good priced by a …rm at $1360?
(c) Investments fall during the course of a year by 7%. Find the value of
an investment at the end of the year if it was worth $9500 at the
beginning of the year.
(d) a decrease of 30% followed by a decrease of 40%
(e) an increase of 10% followed by a decrease of 50%.

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Index numbers

Economic data often take the form of a time series; values of

economic indicators are available on an annual, quarterly or monthly
basis.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 5 / 14

Index numbers

Economic data often take the form of a time series; values of

economic indicators are available on an annual, quarterly or monthly
basis.
Index numbers enable us to identify trends and relationships in the
data.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 5 / 14

Index numbers
Example

Table 3.1 shows the values of household spending (in billions of dollars)
during a 5-year period.

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Index numbers
Example

Index number = scale factor from base year 100, i.e.

xt
It /0 = 100
x0

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Index numbers
Example

index number = scale factor from base year 100, ie.

xt
It /0 = 100
x0

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 8 / 14

Index numbers:
percentage change between two periods

Based on the same data in Table 3.2 we have:

The percentage change beteen 2000 and 2002 is 102.8
100 = 1.028, that is
household spending have increased by 2.8% between 2000 and 2002.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 9 / 14

Index numbers:
percentage change between two periods

Based on the same data in Table 3.2 we have:

The percentage change beteen 2000 and 2002 is 102.8
100 = 1.028, that is
household spending have increased by 2.8% between 2000 and 2002.
The percentage change beteen 2001 and 2003 can be calculated by
two manners:

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 9 / 14

Index numbers:
percentage change between two periods

Based on the same data in Table 3.2 we have:

The percentage change beteen 2000 and 2002 is 102.8
100 = 1.028, that is
household spending have increased by 2.8% between 2000 and 2002.
The percentage change beteen 2001 and 2003 can be calculated by
two manners:
1 the index number has increased by 105.3 103.8 = 1.5 so the
1.5
percentage increase is 103.8 100 = 1.45%

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 9 / 14

Index numbers:
percentage change between two periods

Based on the same data in Table 3.2 we have:

The percentage change beteen 2000 and 2002 is 102.8
100 = 1.028, that is
household spending have increased by 2.8% between 2000 and 2002.
The percentage change beteen 2001 and 2003 can be calculated by
two manners:
1 the index number has increased by 105.3 103.8 = 1.5 so the
1.5
percentage increase is 103.8 100 = 1.45%
2 the scale factor of this change is 105.3
103.8 = 1.0145 which corresponds to
an 1.45% increase.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 9 / 14

Index numbers:
percentage change between two periods

Based on the same data in Table 3.2 we have:

The percentage change beteen 2000 and 2002 is 102.8
100 = 1.028, that is
household spending have increased by 2.8% between 2000 and 2002.
The percentage change beteen 2001 and 2003 can be calculated by
two manners:
1 the index number has increased by 105.3 103.8 = 1.5 so the
1.5
percentage increase is 103.8 100 = 1.45%
2 the scale factor of this change is 105.3
103.8 = 1.0145 which corresponds to
an 1.45% increase.

The percentage change beteen 2001 and 2002 is 102.8

103.8 = 0.990 < 1
re‡ecting the fact that output has fallen by 1% (1 0.990 = 0.01).

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Index numbers:
Laspeyre and Paasche indices

Unit cost of inputs

In year 0, a …rm used 70 units of labour, 25 units of energy, 10 units of

communication and 140
units of raw materials.
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Index numbers:
Laspeyre and Paasche indices

Since components have di¤erent "weights" we have:

L 23 70 + 10 25 + 14 10 + 9 140 sum P1 Q0
I1/0 = 100 = 100 = 1
16 70 + 7 25 + 12 10 + 5 140 sum P0 Q0

Index numbers that are weighted according to the quantity consumed

in the base year are called Laspeyre indices.

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Index numbers:
Laspeyre and Paasche indices

Since components have di¤erent "weights" we have:

L 23 70 + 10 25 + 14 10 + 9 140 sum P1 Q0
I1/0 = 100 = 100 = 1
16 70 + 7 25 + 12 10 + 5 140 sum P0 Q0

Index numbers that are weighted according to the quantity consumed

in the base year are called Laspeyre indices.
Index numbers that are weighted according to the quantity consumed
in the current year are called Paasche indices.

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In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.

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In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.
the basket of goods and services is changed periodically to re‡ect
changing patterns of household expenditure.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 12 / 14

In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.
the basket of goods and services is changed periodically to re‡ect
changing patterns of household expenditure.
Seasonal variations are taken into account

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 12 / 14

In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.
the basket of goods and services is changed periodically to re‡ect
changing patterns of household expenditure.
Seasonal variations are taken into account
Taking into account the in‡ation is crucial when trying to interpret a
time series that involves a monetary value.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 12 / 14

In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.
the basket of goods and services is changed periodically to re‡ect
changing patterns of household expenditure.
Seasonal variations are taken into account
Taking into account the in‡ation is crucial when trying to interpret a
time series that involves a monetary value.
Economists deal with this by distinguishing between nominal and real
data.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 12 / 14

In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.
the basket of goods and services is changed periodically to re‡ect
changing patterns of household expenditure.
Seasonal variations are taken into account
Taking into account the in‡ation is crucial when trying to interpret a
time series that involves a monetary value.
Economists deal with this by distinguishing between nominal and real
data.
Nominal data are the original, raw data. These are based on the prices
that prevailed at the time (current prices)

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 12 / 14

In‡ation
De…nition

The annual rate of in‡ation is the average percentage change in a

given selection (basket) of goods and services, over the previous year.
the basket of goods and services is changed periodically to re‡ect
changing patterns of household expenditure.
Seasonal variations are taken into account
Taking into account the in‡ation is crucial when trying to interpret a
time series that involves a monetary value.
Economists deal with this by distinguishing between nominal and real
data.
Nominal data are the original, raw data. These are based on the prices
that prevailed at the time (current prices)
Real data are the values that have been adjusted to take in‡ation into
account.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 12 / 14

In‡ation

Example

The raw "Salary" stands for Nominal salary.

The raw "in‡ation" stands for the annual rates of in‡ation (percentage
change in prices between January 1st and December 31th of each year
generally)
Compare nominal and real salaries at the 1991 constant prices.

M.M. Ben Jemaa (G.B.S) Mathematics of Finance ... 13 / 14

In‡ation

Example

Example
By choosing 1991 as the base year and calculate the value of the house at
‘1991 prices’. we have:
19.8
W92/91 = 1.043 = 18.98 one year backtrack
23.5
W93/91 = 1.043 1.04 = 21.66 two years backtrack
26
W94/91 = 1.043 1.04 1.035 = 23.16 three years backtrack
W90/91 = 17.3 1.049 = 18.15 one year forward

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