THE INSTITUTE OF FINANCE MANAGEMENT (IFM)

Department of Mathematics

Business Statistics 1
MTU 07203

INDEX NUMBERS
Index Number
Definition
• An index number is, in part, a ratio of a
measure taken during one time frame to that
same measure taken during another time
frame. Or
• An Index number is a number that expresses
the relative change in price, quantity, or value
compared to a base period.
Example of Index Number
Examples of specific indexes are
a. Employment cost index
b. Price index for construction
c. Index of manufacturing capacity
d. Producer price index
e. Consumer price index
f. Dow Jones industrial average
g. Index of output etc.
 Characteristics of Index numbers

The Index Number

a. Usually expressed in terms of a base of 100

b. Has a base period
c. Is a ratio often multiplied by 100
d. Expressed as a percentage that serve as an
alternative to compare raw numbers.
 Uses of Index Number

Index numbers are descriptive measures that

are used to
• Compare phenomena from one time period to
another (comparison between two different
periods).
• Relate information about stock markets,
inflation, sales, exports and imports,
agriculture etc.
Problems in Index Number Construction

i. Collection of data
• The availability and comparability of data to get the correct data is
very difficult as we know that the primary data which are always
the appropriate ones is costly and time consuming

ii. Selection of Base time Period

• In the calculation of index number we have two important periods;
a. The base period where the reference is to be made
b. The current period – period whose data compared to those of
base year
 iii. The choice of the suitable formula
• There are several methods in which the index number
can be derived. Different method gives different index
numbers. The choice among the different formulae
should depend on the particular use to be made on it

iv. Selection of component commodity

• For the single item or commodity it is easier to get a price
index, but if the index is of general purpose i.e. to
compare the cost of link, here the selection of item to be
included should be properly made considering the place,
habit and time.
 Simple Index  Number ()
• The equation for computing a simple index number is as
follows
 

where; X0 is the quantity, price, or cost in the base year

Xt is the quantity, price, or cost in the year of
interest
It is the index number for the year of interest
 Price Relative (PR)

• Price Relative is the ratio of the price of the single

commodity in a given period called current period to its
price in another period called base period.

where, Pt is the price for current period

Po is the price for base period
 Example

•The  price of a standard lot at the Shady Rest Cemetery in

2011 was Tshs 6000. The price rose to Tshs10000 in 2015.
What is the price index for 2015 using 2011 as the base
period?
Solution

PR = 166.7
Interpreting this result, the price of a cemetery lot increased
66.7 percent from 2011 to 2015
Example 2
The following table shows the average price of one liter
of petrol in Dar es Salaam from 2005 to 2010

Year 2005 2006 2007 2008 2009 2010

Tshs 450 560 750 900 1000 1100

Using the 2006 - 2007 as the base year, find the price
relatives of one liter of petrol compounding to all the
given years
Solution

The arithmetic mean of the price for the year 2006 – 2007,
560  750 560  750
p   655
X2   655
0

2
Year Tshs Price relative
2005 450 x 100= 68.7

2006 560 x 100 = 85.5

2007 750 x 100 = 114.5

2008 900 x 100 = 137.4

2009 1000 x 100 = 152.7

2010 1100 x 100 = 167.9

 Simple Average of Relative Price Index

•Procedure
  in computation of Simple Average of
Relative Price Index
1. Calculate a separate relative index for each item
2. Average all of relative indexes calculated.
3. Relative Price Index is given as

where, n is the total number of commodities

Example 3:
The price for five commodities for two years, 2000 and 2010 by a
certain family is given by the following table below

Item 2000 2010

Price Po (Tshs) Price Pt (Tshs)
Eggs(dozen) 185 298
Milk (liter) 88 198
mangoes (500g) 146 175
Orange juice (355ml) 158 170
Tea bags (500g) 440 475

Calculate the simple average of relative price index use 2000 as a

base period
Solution:

Item 2000 2010 Simple Index

Price Po (Tshs) Price Pt (Tshs)

Eggs(dozen) 185 298 x100 = 161

Milk (liter) 88 198 x100 = 250

mangoes (500g) 146 175 x100 = 119.9

Orange juice (355ml) 158 170 x100 = 107.6

Tea bags (500g) 440 475 x100 = 108

Pt
Total  P 100  746.5
0
•The
  total number of commodities, n = 5.
 Simple Aggregate Index (SAI)

••  Simple Aggregate Index is the ratio of the sum of

prices of all commodities in a given period called

current period to the sum of price in another period
called base period.
• Simple aggregate index also is called
unweightedaggregate index given by
100
 Characteristics of Simple Aggregate Index

Simple Aggregate Index

i. Is the sum the prices (rather than the indexes) for
the two periods
ii. Determine the index based on the totals.
iii. Is constructed by collecting a number of similar
items.
Example 4

The average price in Tshs (‘000’) for stone, cement,

sand and building block for the two years 2005 and
2010 are given in table below
Item 2005 2010
1ton Stone 87 160
1ton cement 56 125
1ton building block 98 200
1 ton sand 67 135
Calculate the simple aggregate price index for the year
2010 using 2005 as a base.
Solution
Item P0 (2005) Pn (2010)
1 ton Stone 87 160
1 ton cement 56 125
1 ton building block 98 200
1 ton sand 67 35

1 ton sand = 308 =602

 
100
100
 Disadvantage of the Simple Aggregate Index

• The method do not put in considerations the

unity used to give the weight of the difference
commodities
• It assumes equal qualities have been used on
each commodity
Exercises
1. Statistics Canada results show that the number of farms in
Canada dropped from 276 548 in 1996, to an estimated 246
923 in 2001. What is the index for the number of farms in
2001 based on the number in 1996?

2. Suppose the whole sales price of maize, wheat flour and rice
per bag varies as here below
Commodity 2000 2010
  Price in Tshs per bag
Maize 2500 3500
Wheat flour 3000 4500
Rice 3500 5000

Calculate the simple average of relative price index use 2000

as base year.
3. The average price in Tshs for rice, maize and sugar
for the two years 2000 and 2011 are given in table
Item 2000 2011
1kg rice 650 1200
1kg maize 400 800
1 kg sugar 700 1000

Calculate the simple aggregate price index for

the year 2011 using 2000 as a base.
 Weighted Index Number

• There two main types of weighted aggregate

indexes we will discuss in this course
i. Laspeyre’s
ii. Paasche’s
• The two methods of computing a weighted price
index they differ only in the period used for
weighting.
 Laspeyre’s index
• The Laspeyres method uses base-period
weights
• that is, the original prices and quantities of the
items bought to find the percent change over
a period of time in either price or quantity
consumed depending on the problem.
 Laspeyre’s Price Index
 •
Laspeyres Price Index is the weighted aggregate
index formed by considering the quantity of the base
period as weight. It is defined as
100

Laspeyre’s Quantity Index

•Laspeyres
  Price Index is the weighted aggregate index
formed by considering the prices of the base period as
weight. It is defined as
100
Example 5

The price for six commodities for two years, 2000 and 2010 and their
consumed quantities by a certain family is given by the following table below.

Item 2000 2010

Price Po (Tshs) Quantity (qo) Price Pt Quantity
(Tshs) (qn)
Brown bread (loaf) 77 50 198 55
Eggs(dozen) 185 26 298 20
Milk (liter) 88 102 198 130
mangoes (500g) 146 30 175 40
Orange juice (355ml) 158 40 170 41
Tea bags (500g) 440 12 475 12
Use 2000 as a base year to calculate Laspeyre’s Price Index and Laspeyre’s
Quantity Index
Solution
Item 2000 2010 po qo ptqo poqt
Price Po Quantity (qo) price Pt Quantity (qt)
(Tshs) (Tshs)

Brown bread (loaf) 77 50 198 55 3850 9900 4235

Eggs(dozen) 185 26 298 20 4810 7748 3700

Milk (liter) 88 102 198 130 8976 20196 11440
mangoes (500g) 146 30 175 40 4380 5250 5840

Orange juice (355ml) 158 40 170 41 6320 6800 6478

Tea bags (500g) 440 12 475 12 5280 5700 5280

 Total
  p o qo p t qo P q
0 t

 33616  55594  36973

Laspeyre’s Price Index
LPI 

  P tq o

  100

  P o q o


 55594 
LPI     100
 33616 

LPI  165 . 4

Based on this analysis we conclude that the price of this group of

items has increased 65.4 percent in the ten year period.
Laspeyre’s Quantity Index


LQI  
q tpo 
  100

 q 
op 0 

 36973 
LQI     100
 33616 

LQI  11 0

Based on this analysis we conclude that the quantity of this group of

items has increased 10 percent in the ten year period
 Paasche’s Index

The Paasche’s method uses current - year weights for

the denominator of the weighted index.

Paasche’s Price Index

This is the type of weighted aggregate index number

considering the quantity of the current year’s period as
weights. It is defined as;
 
100
Paasche’s Quantity Index

•A  type of weighted aggregate index number formed by

considering price of the current period as weights. It is
defined as
100

Example 6: Use example 5 to calculate

a)Paasche’s Price Index
b)Paasche’s Quantity Index
 Example 6: Use example 5

Item 2000 2010        

Price po Quantity Price pt Quantity poqt Ptqt qop t  

(Tshs) (qo) (Tshs) qn
Brown bread (loaf) 77 50 198 55 4235 1089 9900  
0
Eggs(dozen) 185 26 298 20 3700 5960 7748  

Milk (liter) 88 102 198 130 1144 2574 2019  

0 0 6
Mangoes (500g) 146 30 175 40 5840 7000 5250  

Orange juice 158 40 170 41 6478 6970 6800  

(355ml)
Tea bags (500g) 440 12 475 12 5280 5700 5700  

 
 
   
p q
o t p q
t t q o Pt
 36973  62260  55590
• Paasche’s Price Index

PPI  
 Pt q t

  100

  Po q t



 62250 
PPI     100
 36973 
PPI  1 68 . 4

• Paasche’s Quantity Index


PQI  
q tpt 
  100

 q 
op t 

 185500 
PQI     100
 162500 
PQI  11 2
• The Paasche index is more reflective of the
current situation. It should be noted that the
Laspeyres index is more widely used. The
Consumer Price Index, the most widely
reported index, is an example of a Laspeyres
index.
Advantage and disadvantages of Laspeyres’ and Paasche’s

Laspeyres’
Advantages Requires quantity data from only the base period. This allows a more meaningful
comparison over time. The changes in the index can be attributed to changes in
the price.

Disadvantages Does not reflect changes in buying patterns over time. Also, it may
overweight goods whose prices increase.
 
Paasche’s
Advantages Because it uses quantities from the current period, it reflects current buying
habits.
Disadvantages Disadvantages It requires quantity data for each year, which may be difficult to
obtain. Because different quantities are used each year, it is impossible to
attribute changes in the index to changes in price alone. It tends to overweight the
goods whose prices
 Advantage of Weighted over the Simple Aggregate

In weighted index the weight of each of the

items is considered.
 Fisher’s index

• It is the geometric mean of the Laspeyres and

Paasche indexes. It is determined by taking the kth
root of the product of k positive numbers
Fisher's ideal index   Laspeyre's Index   Paasche's index

• Fisher’s index combines the best features of both

Laspeyres and Paasche. That is, it balances the
effects of the two indexes.
•Fisher’s
  Ideal Price Index
This is simply given by the following formula

Fisher’s Ideal Quantity Index

This is simply given by the following formula

Use data in example 5 and 6 above to calculate

a) Fisher’s Ideal Price Index
b)Fisher’s Ideal Price Index
•  
• Solution
a. Fisher’s Ideal Price Index

b. Fisher’s Ideal Price Index