8.1. Index Numbers Flashcards
Simple indices…
Used if we only have one item in our series.
For example, comparing the price of houses from 2020-2024.
One year is designated as a base year (equal to 100) and the index values for the other values are calculated from there.
You can also change the base year which changes the index values.
Unweighted indices…
This considers multiple commodities in the index rather than just one.
For example, comparing the price of houses and flats from 2020-2024.
One year is still designated as the base year and the denominator of the fraction uses prices from this year.
There is no consideration of quantity.
Laspeyres…
A weighted index.
Uses base period weights. The weights do not change over time.
It focuses on changing price of a constant basket of goods.
However, weights may become unrepresentative as consumption patterns change.
We also must consider whether the base year is representative of general consumption.
Paasche…
Sets current period weights. Focuses on the changing price of goods that are currently consumed.
+ves and -ves of Laspeyres…
Advantages:
Easy calculation: this index is relatively straightforward to calculate as it involves using fixed weights based on a base period.
Consistency: since it uses fixed weights from one base period, Laspeyres is consistent over time and can provide a stable comparison of price changes.
Reflects consumer preferences: Laspeyres index reflects the purchasing habits of consumers in the base period, which may be useful for certain applications where historical comparisons are important.
Disadvantages:
Substitution bias: Laspeyres index does not account for changes in consumer preferences (i.e. substitution away from certain products in response to price changes). This can lead to an over or underestimation of the price index.
Quality changes: Laspeyres does not adjust for changes in product quality over time, which can affect the accuracy of the index.
+ves and -ves of Paasche…
Advantages:
Accounts for substitution bias: the Paasche index incorporates changes in consumer behaviour and consumption patterns by using the current period quantities, making the index less susceptible to substitution bias.
Reflects current consumption: since it uses current period quantities, it reflects the most recent consumption patterns and, thus, provides a more accurate measure of price changes.
Disadvantages:
Complex calculations: the Paasche index can be more complex to calculate as it involves more steps (i.e. using varying weights based on the current period).
Reflects current consumption: while reflecting current consumption patterns can have its advantages, it can also make the index unrepresentative if there are significant, unexpected and short-lived changes in consumption.
Relative magnitudes…
Laspeyres index is usually higher, as households respond to changing relative prices by switching their consumption in the direction of inputs which are becoming relatively cheaper. By using current weights, the Paasche index captures this change, whereas the Laspeyres index only uses base weights, hence overstating the values.
Can the Paasche index be higher? Not commonly, but it is possible. This could happen if consumers tended to buy more of the goods whose prices have increased (inelastic demand).
Can the two indices have equal values? In some cases, yes. This particularly occurs when there is no change in quantities consumed between the base period and the current period, or when the changes in quantities offset each other in a way that balances the effect on the index.
Fisher price index…
Uses the geometric mean to find a solution to the different magnitudes.
Multiplies both together and square roots.
Quantity indices…
Can be Laspeyres or Paasche and follows the same pattern, but changes quantities and fixes prices.
Expenditure indices…
Referred to as a value index.
Shows how expenditure changes over time.
RPI…
Consists of the prices of around 550 items.
Weights are based on households’ expenditure derived from the Expenditure and Food Survey.
Weights are updated every January.
Within each calendar year, weights remain constant.
It takes the form of a Laspeyres index.
This has lost its status as a National Statistic.
CPI…
Forms the basis of the Government’s inflation target.
Uses expenditure weights, based on National Accounts estimates a household’s final consumption.
CPI excludes certain housing costs, PRI includes housing costs.
CPIH includes housing costs.
Deflating series…
Distinguishing between nominal and real values.
This adjusts nominal values, turning them into real values, but adjusts them for changes in the price level.
Deflates to remove the effects of inflation over time.
Therefore: real value=(nominal value / price index) * 100
Chain indices…
Can be used to link together several separate, shorter indices.
Indices examples…
Please see Google Doc 8.1. Index Numbers for examples.
