Index Numbers

Chapter 15

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 Review

 What is an index?
 How is an index different from growth rates?
Is there a relationship between the two

 Advantages of using an Index

 Different types of Index

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 GOALS

1. Construct and interpret a value index.

2. Explain how the Consumer Price Index is

constructed and interpreted.

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 Value Index

 A value index measures changes in both the price and

quantities involved.

 A value index, such as the index of department store

sales, needs the original base-year prices, the original
base-year quantities, the present-year prices, and the
present year quantities for its construction.

 Its formula is:

15-4
 Value Index - Example

The prices and quantities sold at the Waleska Clothing Emporium

for various items of apparel for May 2000 and May 2009 are:

What is the index of value for May 2009 using May 2000 as the base period?

15-5
 Value Index - Example

15-6
 Value Index

 Benefit of Calculating Value Index:

 Interpretation of Last Example:

– Value of Apparel Sales Increased 17.8 percent
from May 2000 to May 2009.

15-7
 Example

Price Production (in millions of

bushels)

Grains 2001 2017 2001 2017

Oats 3 4 10,000 9,000

Wheat 2 5 600 200

Corn 10 8 3,000 5.000

What is the index of value for 2017 using 2001 as the base
period?

15-8
 Example

15-9
 What is the Consumer Price Index
(CPI)
 Describes Changes in Prices from One Period To Another.
 Using Representative “Market Basket” of Goods and
Services.

 Economic Indicator of Inflation.

 In the U.S., a separate CPI is calculated for food, apparel,
transportation, medical care, housing etc.
 Determine The Degree To Which Purchasing Power is
Being Eroded By Price Increases.

15-10
 Producers Price Index
 Formerly called the Wholesale Price Index, it dates back to 1890
and is also published by the U.S. Bureau of Labor Statistics.

 It reflects the prices of over 3,400 commodities.

 Price data are collected from the sellers of the commodities, and it
usually refers to the first large-volume transaction for each
commodity.

 It is a Laspeyres-type index.

15-11
 Dow Jones Industrial Average (DJIA)

 DJIA is an index of stock prices, but

perhaps it would be better to say it is
an “indicator” rather than an index.
 It is supposed to be the mean price of
30 specific industrial stocks.
 However, summing the 30 stock prices
and dividing by 30 does not calculate
its value. This is because of stock
splits, mergers, and stocks being
added or dropped.
 When changes occur, adjustments are
made in the denominator used with the
average.

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 CPI Uses

 It allows consumers to determine the effect of

price increases on their purchasing power.
 It is a yardstick for revising wages, pensions,
alimony payments, etc.
 It is an economic indicator of the rate of
inflation in the United States.
 It computes real income:
 real income = money income/CPI X (100)

15-13
 CPI Uses - Formulas

15-14
 CPI and Real Income

CPI is used to determine real disposable personal

income, to deflate sales or other variables, to find the
purchasing power of the dollar, and to establish cost-
of-living increases.

15-15
 CPI as a Deflator

 A price index can also be used to “deflate” sales or

similar money series. Deflated sales are determined
by:
.

15-16
 CPI and Real Income

The Consumer Price Index is also used to determine

the purchasing power of the dollar.

Suppose the Consumer Price Index this month is 200.0 (1982–84

100). What is the purchasing power of the dollar?

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 Shifting the Base

 Two Time Series Can Be Easily Compared, if

they have the same base period.

15-18
 Same Base Year Across Time Series

15-19
 Easier Comparison

 Because the base year is 1982-84, we can

easily tell the percentage price across all the
categories till 2009.

 For instance, the price of all items increased

by 114.5% and the price of medical care
increased by 275% during the time period
1982-84 till 2009.

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 Different Base Periods

 Want to compare producer price index for crude materials and industrial
production index.
 But, both are using different base periods.
Industrial Production Index Producer Price Index
  ( 2002=100) (1982=100)
2004 103.8 159.1
2005 107.2 182.3
2006 109.7 185
2007 111.3 206.9
2008 108.8 251

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 How to Compare The Two Series

 Select the same year as the base year for

both time series and re-calculate the indices.
Industrial Production Index Producer Price Index
  ( 2004=100) (2004=100)

2004 100.0 100.0

2005 103.3 114.6

2006 105.7 116.3

2007 107.2 130.0

2008 104.8 157.8

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