CPI (Laspeyre’s Index)

It is the cost of living index used in measuring inflation, that is how much a
particular category of consumers are required to spend in the current period as a
percentage of what they used to spend in the base period to buy the same basket
of good as they bought in the base period.
Assumption: The families in a given income bracket tend to have broadly similar
pattern of expenditures.

• Base Shifting: We can shift the base of a series of index no. if the given base
becomes old one using the given formula.
• Deflating: A technique which is used to remove the effect of inflation from
the index numbers. It can be used to calculate the real income, if the money
income is given along with the price index.
(Eg. increase in money income, but increase in price would cause the real
income to remain fixed)
• Splicing: It is a technique used when an old series is discontinued with the
old base year and a new series is to be started with a new base year and we
need to connect the two series into one new continuous series.

PROBLEMS IN CONSTRUCTION OF INDEX NUMBERS

Purpose, selection of prices-items / base year/weights/average/formula
• It is necessary to be clear about the purpose for which the index is to be
used.
Eg. use CPI as the deflator to covert money income into real income.
• The selection of prices and the items to be included in an index is
an important problem which must be handled.
Eg. If we want to measure the cost of a village house then it wouldn’t be
ideal to gather info related to prices of heavy steel.
• Selection of the base year – since all the movements in the index
are analyzed with reference to the base year.(should be a normal year in
which the value is neither very high not very low and must not be too
distant)
• Using apt weights
However for index to be useful, only approximate accuracy maybe
sufficient.
• Using the right average in average of relatives
 Any measure of central tendency can work, weighted arithmetic mean is
most commonly used since it is easier to understand.
• Accuracy of the formula: Different formulas yield different results
when applied to the same data, however fischer’s test is considered to be
the best one but with the limitation that it uses current year quantities the
info on which is difficult to collect, the above problem is tackled by
Laspeyre’s method which is more practical.