Unit 5: Index Numbers

S. Nakale
University of Namibia
(School of Accounting)

2021 Academic Year

 Learning outcome
At the end of this lecture, you must be able to:

 Define and explain the purpose of index numbers

 Develop and interpret indexes to measure price changes over time
 Develop and interpret indexes to measure quantity changes over
time

2021 Academic Year

 Introduction
 An index number is a measure (usually composite/aggregate) of the
change in a variable i.e. price compared/relative to a
specified/starting period which is referred to as the base period. The
value of the index in the base period is equal to 100.

 A variety of indexes are published on a regular basis to help

individuals understand current business and economic conditions.

 The most widely known index is the Consumer Price Index (CPI) which
measure the changes in prices consumers pay for items purchased
over a period of time. The CPI is used as a measure of inflation in the
economy.

2021 Academic Year

 Price Relative
 The simplest form of a price index.
 It shows how the current price per unit for a given
item compares to a base period price per unit for
the same item.

𝑃𝑟𝑖𝑐𝑒 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝒕
𝑃𝑟𝑖𝑐𝑒 𝑟𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝒕 = (100)
𝑃𝑟𝑖𝑐𝑒 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

 Note:
o If the price relative index is below 100 in a certain period, it means
that the price of the item in that certain period was below the
base period price for the same item i.e. decline in price.
o If the price relative index is above 100 in a certain period, it means
that the price of the item in that certain period was above the
base period price for the same item i.e. an increase in price.
2021 Academic Year
 Quantity Relative
 It shows how the current quantity per unit for a given item
compares to a base period quantity per unit for the same item.

𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝒕
𝑄𝑢𝑎𝑛𝑖𝑡𝑦 𝑟𝑒𝑙𝑎𝑡𝑖𝑣𝑒 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝒕 = (100)
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

 Note:
o If the quantity relative index is below 100 in a certain period,
it means that the quantity of the item in that certain period
was below the base period quantity for the same item i.e.
decline in quantity.
o If the quantity relative index is above 100 in a certain period,
it means that the quantity of the item in that certain period
was above the base period quantity for the same item i.e.
an increase in quantity.
2021 Academic Year
 Aggregate Price Indexes
 We are often more interested in the general price
change for a group of items taken as a whole.

 Aggregate price indexes are used in measuring the

combined change of a group of items.

 Example: An index to measure the cost of living over

time would be based on the price changes of items
such as food, housing, transportation, clothing, medical
care, education etc.

2021 Academic Year

 Aggregate Quantity Indexes
 We are often more interested in the general quantity
change for a group of items taken as a whole.

 Aggregate quantity indexes are used in measuring the

combined change of a group of items.

2021 Academic Year

 Unweighted Aggregate Price
Indexes
 An unweighted aggregate index is developed by
summing the unit prices in the year of interest and
dividing that sum by the sum of nit prices in the base
year:
𝑃𝑖𝑡
𝐼𝑡 = 100
𝑃𝑖0
Note:
𝑃𝑖𝑡 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡
𝑃𝑖0 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

2021 Academic Year

 Unweighted Aggregate Quantity
Index
𝑄𝑖𝑡
𝐼𝑡 = 100
𝑄𝑖0
Note:
𝑄𝑖𝑡 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡

𝑄𝑖0 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

2021 Academic Year

 Weighted Aggregate Price Index
 The unweighted price index is sensitive to high-priced items and is
thus influenced by the items with large per-unit prices.
 This can be overcome by weighting each item according to its
importance.
 The quantity of usage is the best measure of importance.
•
 The weighted aggregate price index in period t is given by:

𝑃𝑖𝑡 𝑄𝑖
𝐼𝑡 = 100
𝑃𝑖0 𝑄𝑖

Note:
𝑃𝑖𝑡 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡
𝑃𝑖0 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝑄𝑖 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑢𝑠𝑎𝑔𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖.

2021 Academic Year

 Weighted Aggregate Quantity
Indexes
The unweighted quantity index is sensitive to
the consumption of items.
This can be overcome by weighting each item
according to its importance.
The prices can be used as weights.

2021 Academic Year

 Laspeyres Weighted Aggregate
Price Index
 A special case of the weighted price index where
the quantities are determined from base period
usages.
 The Laspeyres price index in period t is given by:

𝑃𝑖𝑡 𝑄𝑖0
𝐼𝑡 = 100
𝑃𝑖0 𝑄𝑖0

Note:
𝑃𝑖𝑡 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡
𝑃𝑖0 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝑄𝑖0 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑢𝑠𝑎𝑔𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑.

2021 Academic Year

 Laspeyres Weighted Aggregate
Quantity Index
𝑄𝑖𝑡 𝑃𝑖0
𝐼𝑡 = 100
𝑄𝑖0 𝑃𝑖0

Note:
𝑄𝑖𝑡 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡
𝑄𝑖0 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝑃𝑖0 = 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑.

2021 Academic Year

 Paasche Weighted Aggregate Price
Index
 A special case of the weighted price index where the
quantities are revised each period.

 The Paasche price index in period t is given by:

𝑃𝑖𝑡 𝑄𝑖𝑡
𝐼𝑡 = 100
𝑃𝑖0 𝑄𝑖𝑡

Note:
𝑃𝑖𝑡 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡
𝑃𝑖0 = 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝑄𝑖𝑡 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑢𝑠𝑎𝑔𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡.

2021 Academic Year

 Paasche Weighted Aggregate
Quantity Index

𝑄𝑖𝑡 𝑃𝑖𝑡
𝐼𝑡 = 100
𝑄𝑖0 𝑃𝑖𝑡

Note:
𝑄𝑖𝑡 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡
𝑄𝑖0 = 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑎𝑠𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝑃𝑖𝑡 = 𝑝𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝑖𝑡𝑒𝑚 𝑖 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡.

2021 Academic Year

 Exercise 16
Consider the following information:
Item Unit price Usage quantity
May 2021 June 2021 May 2021 June 2021
Litre of fuel 12.30 12.50 105 108
Engine oil 25.20 26.30 3 2
Tire 1300.00 1350.00 2 2
Insurance policy 2300.00 2150.00 1 1
Required:
Calculate and interpret the following:

a) Price relatives for the four items.

b) Quantity relatives for the four items.
c) Unweighted aggregate price index for June 2021.
d) Unweighted aggregate quantity index for June 2021.
e) Weighted aggregate price index for June 2021 using the Laspeyres method.
f) Weighted aggregate quantity index for June 2021 using the Laspeyres
method.
g) Weighted aggregate price index for June 2021 using the Paasche method.
h) Weighted aggregate quantity index for June 2021 using Paasche method.
2021 Academic Year
 Exercise 16 Solution
Consider the following information:
Item Unit price Usage quantity
May 2021 June 2021 May 2021 June 2021
Litre of fuel 12.30 12.50 105 108
Engine oil 25.20 26.30 3 2
Tire 1300.00 1350.00 2 2
Insurance policy 2300.00 2150.00 1 1

a) Price relatives for the four items.

Item Price relative Interpretation

Litre of fuel 12.5 Price of litre of fuel increased by
100 = 101.63
12.3 1.63% between May and June
2021.
Engine oil 26.3 Price of engine oil increased by
100 = 104.37
25.2 4.37% between May and June
2021.
Tire 1350 Price of car tire increased by
100 = 103.85
1300 3.85% between May and June
2021.
Insurance policy 2150 Motor vehicle insurance policy
100 = 93.48
2300 instalment decreased by 6.52%
between May and June 2021

2021 Academic Year

 Exercise 16 Solution
Consider the following information:
Item Unit price Usage quantity
May 2021 June 2021 May 2021 June 2021
Litre of fuel 12.30 12.50 105 108
Engine oil 25.20 26.30 3 2
Tire 1300.00 1350.00 2 2
Insurance policy 2300.00 2150.00 1 1

b) Quantity relatives for the four items.

Item Quantity relative Interpretation

Litre of fuel 108 Quantity of litres of fuel
100 = 102.86
105 consumed increased by 2.86%
between May and June 2021.
Engine oil 2 Quantity of engine oil
100 = 66.67
3 consumed decreased by
33.33% between May and June
2021.
Tire 2 Number of tires (replaced)
100 = 100
2 between May and June
2021have remained the same.
Insurance policy 1 Number of insurance motor
100 = 100
1 vehicle insurance policies have
remained the same between
2021 Academic Year May and June 2021
 Exercise 16 Solution
Consider the following information:
Item Unit price Usage quantity
May 2021 June 2021 May 2021 June 2021
Litre of fuel 12.30 12.50 105 108
Engine oil 25.20 26.30 3 2
Tire 1300.00 1350.00 2 2
Insurance policy 2300.00 2150.00 1 1

Unweighted aggregate index Interpretation

c) Price (12.5 + 26.3 + 1350 + 2150) The aggregated price for the
= 100 basket of motor vehicle
(12.3 + 25.2 + 1300 + 2300)
maintenance items
decreased by 2.71%
= 97.29 between May and June
2021.
d) Quantity The aggregated quantity for
(108 + 2 + 2 + 1) the basket of motor vehicle
= 100 = 101.8 maintenance items
(105 + 3 + 2 + 1) increased by 1.8% between
May and June 2021.
2021 Academic Year
 Exercise 16 Solution
Consider the following information:
Item Unit price Usage quantity
May 2021 June 2021 May 2021 June 2021
Litre of fuel 12.30 12.50 105 108
Engine oil 25.20 26.30 3 2
Tire 1300.00 1350.00 2 2
Insurance policy 2300.00 2150.00 1 1

Weighted aggregate index – Interpretation

Laspeyres method
e) Price (12.5 ∗ 105 + 26.3 ∗ 3 + 1350 ∗ 2 + 2150 ∗ 1) The aggregated price for the
= 100
(12.3 ∗ 105 + 25.2 ∗ 3 + 1300 ∗ 2 + 2300 ∗ 1) basket of motor vehicle
maintenance items decreased
= 99.59 by 0.41% between May and June
2021, when considering the
quantities of May 2021 as the
weights.

f) Quantity The aggregated quantity for the

(108 ∗ 12.3 + 2 ∗ 25.2 + 2 ∗ 1300 + 1 ∗ 2300) basket of motor vehicle
= 100
(105 ∗ 12.3 + 3 ∗ 25.2 + 2 ∗ 1300 + 1 ∗ 2300) maintenance items increased by
0.19% between May and June
= 100.19 2021, when considering the
prices of May 2021 as the
2021 Academic Year
weights.
 Exercise 16 Solution
Consider the following information:
Item Unit price Usage quantity
May 2021 June 2021 May 2021 June 2021
Litre of fuel 12.30 12.50 105 108
Engine oil 25.20 26.30 3 2
Tire 1300.00 1350.00 2 2
Insurance policy 2300.00 2150.00 1 1

Weighted aggregate index – Interpretation

Paasche method
(12.5 ∗ 108 + 26.3 ∗ 2 + 1350 ∗ 2 + 2150 ∗ 1)
g) Price = 100
The aggregated price for the
(12.3 ∗ 108 + 25.2 ∗ 2 + 1300 ∗ 2 + 2300 ∗ 1) basket of motor vehicle
maintenance items decreased
= 99.58 by 0.42% between May and June
2021, when considering the
quantities of June 2021 as the
weights.

h) Quantity (108 ∗ 12.5 + 2 ∗ 26.3 + 2 ∗ 1350 + 1 ∗ 2150)

The aggregated quantity for the
= 100 basket of motor vehicle
(105 ∗ 12.5 + 3 ∗ 26.3 + 2 ∗ 1350 + 1 ∗ 2150) maintenance items increased by
= 100.18 0.18% between May and June
2021, when considering the
prices of June 2021 as the
2021 Academic Year
weights.
 Additional Exercise 1
Consider the following information regarding items in a basket of
goods for the year 2001 and 2021:
Product 2001 2021
Price (N$) Quantity Price (N$) Quantity
Toothpaste 5.50 7 15.00 12
Lotion 25.00 6 55.00 8
Soap 3.00 10 9.50 18
Deodorant 15.00 5 26.00 6

Required:

a) Calculate and compare the price relative for the four items between 2001 and
2021.
b) Calculate and compare the quantity relatives for the four items between 2001
and 2021.
c) Compute and interpret the weighted aggregate price index using the i)
Laspeyres method and the ii) Paasche method.
d) Compute and interpret the weighted aggregate quantity index using the i)
Laspeyres method and the ii) Paasche method.
2021 Academic Year
 Additional Exercise 1 Solution
Consider the following information regarding items in a basket of goods for the year 2001 and 2021:

Product 2001 2021

Price (N$) Quantity Price (N$) Quantity
Toothpaste 5.50 7 15.00 12
Lotion 25.00 6 55.00 8
Soap 3.00 10 9.50 18
Deodorant 15.00 5 26.00 6

Product a) Price relative b) Quantity relative

Toothpaste 15/5.5*100=272.73 12/7*100=171.43
Lotion 55/25*100=220 8/6*100=133.33
Soap 9.5/3*100=316.67 18/10*100=180
Deodorant 26/15*100=173.33 6/5*100=120
Comparison
Soap has had the highest relative Soap has had the highest relative
price increase (216.67%) and quantity increase (80%) and
deodorant has had the lowest deodorant has had the lowest
relative price increase (73.33%) relative quantity increase (20%)
between 2001 and 2021. between 2001 and 2021.

2021 Academic Year

 Additional Exercise 1 Solution
Consider the following information regarding items in a basket of goods for the year 2001 and 2021:

Product 2001 2021

Price (N$) Quantity Price (N$) Quantity
Toothpaste 5.50 7 15.00 12
Lotion 25.00 6 55.00 8
Soap 3.00 10 9.50 18
Deodorant 15.00 5 26.00 6

c) Compute and interpret the weighted aggregate price index using the i) Laspeyres
method and the ii) Paasche method.

(15 ∗ 7 + 55 ∗ 6 + 9.5 ∗ 10 + 26 ∗ 5)
𝑖) 𝐼2021 = 100 = 224.87
(5.5 ∗ 7 + 25 ∗ 6 + 3 ∗ 10 + 15 ∗ 5)
Altogether, the price of the basket of toiletry items increased by 124.87% between 2001 and 2021
when considering the quantities of usage in 2001 as the weights.

(15 ∗ 12 + 55 ∗ 8 + 9.5 ∗ 18 + 26 ∗ 6)
𝑖𝑖) 𝐼2021 = 100 = 230.98
(5.5 ∗ 12 + 25 ∗ 8 + 3 ∗ 18 + 15 ∗ 6)
Altogether, the price of the basket of toiletry items increased by 130.98% between 2001 and 2021
when considering the quantities of usage in 2021 as the weights.

2021 Academic Year

 Additional Exercise 1 Solution
Consider the following information regarding items in a basket of goods for the year 2001 and 2021:

Product 2001 2021

Price (N$) Quantity Price (N$) Quantity
Toothpaste 5.50 7 15.00 12
Lotion 25.00 6 55.00 8
Soap 3.00 10 9.50 18
Deodorant 15.00 5 26.00 6

d) Compute and interpret the weighted aggregate quantity index using the i)
Laspeyres method and the ii) Paasche method.

(12 ∗ 5.5 + 8 ∗ 25 + 18 ∗ 3 + 6 ∗ 15)

𝑖) 𝐼2021 = 100 = 139.69
(7 ∗ 5.5 + 6 ∗ 25 + 10 ∗ 3 + 5 ∗ 15)
Altogether, the quantity of usage for the basket of toiletry items increased by 39.69% between 2001
and 2021 when considering the prices of 2001 as weights.

(12 ∗ 15 + 8 ∗ 55 + 18 ∗ 9.5 + 6 ∗ 26)

𝑖𝑖) 𝐼2021 = 100 = 143.48
(7 ∗ 15 + 6 ∗ 55 + 10 ∗ 9.5 + 5 ∗ 26)
Altogether, the quantity of usage for the basket of toiletry items increased by 43.48% between 2001
and 2021 when considering the prices of 2021 as weights.

2021 Academic Year

 Additional Exercise (Past Exam)
The prices and usage quantities for two products in 2005 and 2007
are given in the table below:

Quantity Price (N$)

Product 2005 2007 2005 2007

Q 10 25 100.00 120.00

P 2000 3000 22.00 25.00

 Calculate the price relatives for each product in 2007 using 2005 as the base
year.

 Calculate and interpret the Paasche price and quantity indexes for 2007 using
2005 as the base year.

2021 Academic Year

 Additional Exercise (Past Exam) Solution
The prices and usage quantities for two products in 2005 and 2007 are given in the table below:

Quantity Price (N$)

Product 2005 2007 2005 2007

Q 10 25 100.00 120.00

P 2000 3000 22.00 25.00

 Calculate the price relatives for each product in 2007 using 2005 as the base
year.

Product Price relative Interpretation

Q 120 The price for product

= 100 = 120
100 Q increased by 20%
between 2005 and
2007.
P 25 The price for product
= 100 = 113.64
22 P increased by 13.64%
between 2005 and
2007.
2021 Academic Year
 Additional Exercise (Past Exam) Solution
The prices and usage quantities for two products in 2005 and 2007 are given in the table below:

Quantity Price (N$)

Product 2005 2007 2005 2007

Q 10 25 100.00 120.00

P 2000 3000 22.00 25.00

 Calculate and interpret the Paasche price and quantity indexes for 2007 using 2005 as the base year.

Weighted aggregate Paasche (𝟏𝟐𝟎 ∗ 𝟐𝟓 + 𝟐𝟓 ∗ 𝟑𝟎𝟎𝟎) The aggregate price for the
= 𝟏𝟎𝟎
price index (𝟏𝟎𝟎 ∗ 𝟐𝟓 + 𝟐𝟐 ∗ 𝟑𝟎𝟎𝟎) basket of two items
increased by 13.87% between
= 𝟏𝟏𝟑. 𝟖𝟕 2005 and 2007, when
considering the quantities of
2007 as weights.
Weighted aggregate Paasche (25 ∗ 120 + 3000 ∗ 25) The aggregate quantity for
= 100
quantity index (10 ∗ 120 + 2000 ∗ 25) the basket of two items
increased by 52.34% between
= 152.34 2005 and 2007, when
considering the prices of
2007 as weights.

2021 Academic Year

 Reference
 Anderson D.R, Sweeney D.J and Williams T.A, 2011.
Statistics for Business and Economics, eleventh edition.

 Wegner T, 2016. Applied Business Statistics: Methods

and Excel-Based Applications, fourth edition.

2021 Academic Year