18- 1

Chapter

Eighteen

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

 18- 2

Chapter Eighteen
Index Numbers
GOALS
When you have completed this chapter, you
will be able to:
ONE
Describe the term index.
TWO
Understand the difference between a weighted price index and
an unweighted price index.
THREE
Construct and interpret a Laspeyres Price index.
FOUR
Construct and interpret a Paasche Price index. Goals
 18- 3

Chapter Eighteen continued

Index Numbers
GOALS
When you have completed this chapter, you
will be able to:
FIVE
Construct and interpret a Value Index.
SIX
Explain how the Consumer Price index is constructed and
interpreted.

Goals
 18- 4

An Index Number
expresses the relative
change in price, 36-Month CPI 2000-2002
quantity, or value 4
compared to a base 3

period.

CPI
2

0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Month beginning 1/1/2002

A Simple Index Number

measures the relative change in
just one variable.
Index Numbers
 18- 5
Mr. Wagner
owns stock in Stock 1997 1997 2002 2002
three companies. Price Shares Price Shares
Given is the NWS $1 30 $2 50
price per share
at the end of NPC $5 15 $4 30
1997 and 2002
for the three
GAC $6 40 $6 20
stocks and the
Simple indexes using 1997 as
quantities he
owned in 1997 base year (1997=100)
and 2002. Price Share
($2/$1)(100)=200 (50/30)(100)=167
($4/$5)(100)=80 (30/15)(100)=200
($6/$6)(100)=100 (20/40)(100)=50
Example 1
 18- 6
Easier to Indexes Why
comprehend compute
than actual indexes?
numbers
$ 3 4 5 ,6 5 1 ,2 8 9 ,5 6 0
(percent
change) or 10% ?

Provide convenient
Facilitate ways to express the
comparison of change in the total
unlike series of a heterogeneous
group of items CPI
Bread $0.89

Car $18,000
Dress $200
Surgery $400,000
Why Convert Data to Indexes?
 18- 7
Indexes: Four classifications
Quantity
Price Measures the changes in
quantity consumed from
Measures the changes
the base period to
in prices from a
another period.
selected base period
to another period. Special purpose
Combines and weights a
Value heterogeneous group of series
Measures the change in the to arrive at an overall index
value of one or more items showing the change in
from the base period to the business activity from the
given period (PxQ). base period to the present.
Types of Index Numbers
 18- 8

Price Index Producer Price Index - measures the

average change in prices received in
the primary markets of the US by
producers of commodities in all
stages of processing (1982=100).
C FMMI Chicago Midwe st Manufacturing Inde x

Quantity C FMMI Auto

180
Base year 1997=100

160

140

120

100
Index

80

Federal Reserve 60

40

Quantity Output 20

0
YEAR 1996 1997 1998 1999 2000 2001 2002

Price and Quantity Indexes

 18- 9
Value Index of Feb '03 Retail Sales Base February (Monthly Average of
Oct 1999-Sept 2000)=100

100
90
80

Value
70
60

Index
50
40
30
20
10
0

photographic

valuable gifts
Department
vehicles and

and fixtures
Consumer

watchs and
Furniture
goods and
durable

clocks and
Jewellery,
electrical
goods

Motor

stores
parts
Special purpose

Value and Special Purpose Indexes

 18- 10

Simple Price Index, P From Example 1 a simple

aggregate price index for
pt the three stocks
P (100)
p0
p t
where P (100)
p 0
po the base period price
$2  $5  $6
pt the price at the selected  (100)
$1  $5  $6
or given period.  100.0

Construction of Index Numbers

 18- 11

Weighted index Considers both the price and

the quantities of items
Tends to overweight goods whose prices have increased
Laspeyres Weighted Price Index, P
Two methods of Uses the base period quantities as
computing the weights
price index
 pt q0
Laspeyres method P (100)
Paasche method where
 p0q0
pt is the current price
p0 is the price in the base period
q0 is the quantity consumed in the base
period
 18- 12
Paasche Weighted Price Index, P
Present year weights Tends to overweight
substituted for the original goods whose prices have
base period weights gone down

 pt qt
P (100)
 p0qt
where
qt is the current quantity consumed
p0 is the price in the base period
pt is the current price.
Construction of Index Numbers
 18- 13
Fisher’s Ideal Index


Fisher’s ideal index = (Laspeyres’ index)(Paasche’s index)

The geometric Balances the negative

mean of Laspeyres effects of the
and Paasche Laspeyres’ and
indexes Paasche’s indices.

Requires that a new set of

quantities be determined
each year. Fisher’s Ideal Index
 18- 14

Value Index

Reflects changes in both price and quantity

Both the price and quantity change

from the base period to the given period

pt qt
V (100)
p0q0

Value Index
 18- 15

In 1978 two Millions of employees

consumer price in automobile, steel,
indexes were and other industries
published. One have their wages
was designed for adjusted upward when
urban wage the CPI increases.
earners and
clerical workers.
It covers about one third of the
population. Another was
designed for all urban
households. It covers about
80% of the population.
Consumer Price Index
 18- 16
Usefulness of CPI
It allows consumers to
determine the effect of
price increases on their
purchasing power.
It is an economic
It is a It computes
indicator of the
yardstick for real income:
rate of inflation in
revising real income
the United States.
wages, = money
pensions, income/CPI
alimony (100)
payments, etc. Consumer Price Index
 18- 17

Deflating Sales

Actual sales
Deflated sales  (100)
An approximate index

Determining the purchasing power of the dollar

compared with its value for the base period
$1
Purcha sin g power of dollar  (100)
CPI

Consumer Price Index

17-18
18- 18
Shifting the base
101 115 When two or more series
of index numbers are to be
compared,they may not 101 115
have the same base period.
First select a common base period for all series.

Then use the respective base numbers as the denominators

and convert each series to the new base period.

Consumer Price Index

 18- 19

Stock 1997 1997 2002 2002

Mr. Wagner Price Shares Price Shares
owns stock in NWS $1 30 $2 50
three companies.
Shown below is NPC $5 15 $4 30
the price per GAC $6 40 $6 20
share at the end
of 1997 and Laspeyres Weighted Price Index, P
2002 for the p t q 0
three stocks and P (100)
p 0 q 0
the quantities he $2(30)  $4(15)  $6(40)
owned in 1997  (100)
$1(30)  $5(15)  $6(40)
and 2002. $360
 (100)  104.35
$345
 18- 20
Paasche Weighted Price Index, P
p t q t
P (100)
p 0 q t
$2(50)  $4(30)  $6(20)
 (100)
$1(50)  $5(30)  $6(20) Value Index
$340 p t q t
 (100)  106.25 P (100)
$320 p 0 q 0
$2(50)  $4(30)  $6(20)
Fisher’s Ideal Index  (100)
$1(30)  $5(15)  $6(40)


F = (104.35)(106.25) 
$340
$345
(100)  98.55
=105.3
Example 1 continued