 USE OF INDEKS NUMBER

Index number show exchange supply something variable or variable group there by,
applicable index number,

a) as measure summary in making a policy

b) as indication on a business atmosphere
c) to compare exchange among economic sector
d) To compare exchange such as salary, production and cost life. Increase of salary
should increase more production.
e) as delivery

 PURPOSE WHY CALCULATE INDEX NUMBER

a) Price index: aimed to compare price exchange between two different times.

b) Quantity index: measure quantity comparison or production on two different times.

c) Value index: measure total expenditure comparison and is index of product between
quantity and price

 WHAT IS CPI
Definition of CPI

The Consumer Price Index (CPI) measures quarterly change in the prices of a ”basket” of
goods and services which account for a high proportion of expenditures by urban wage
earners’ household. This basket covers a wide range of goods and services arranged in the
following seven groups: food; drink, tobacco and betel nut; clothing and footwear; rent,
council charges, fuel and power; household equipment and operations; transport and
communication and miscellaneous.

 HOW TO CALCULATE THE CPI

A Price index tells us the percentage change in prices over time. It does not tell us anything
about actual price level.
If we compare index numbers for two different products, we can say that the price of one
product is rising or falling, faster or slower, than the other. We cannot tell from the index
numbers which product is more expensive.

Example: Compare 2 products: Bread and a Motor car

Index numbers are given for bread and a motor car. Both index series begin at 100 in
December 2001, the base period. We may say both sets of index numbers are Base Dec
2001=100.
 Index numbers for Bread and Cars
Base: December 2001 as 100

Table
2: Period Bread Cars

Dec 2001 100.0 100.0

Jan 2002 100.0 100.0

Feb 2002 100.0 100.4

Mar 2002 100.3 101.0

Apr 2002 102.4 101.5

May 2002 104.3 101.5

Jun 2002 105.1 101.6

Jul 2002 105.2 101.9

Aug 2002 105.4 101.9

Sep 2002 105.3 101.9

Oct 2002 105.3 102.4

Nov 2002 105.2 102.4

Dec 2002 105.4 102.4

To calculate the change in price of bread between January 2002 and December 2002 apply
this formula:
Formula 2:

Then for bread

By repeating this exercise for a motor car we can see that car prices increased by 2.4%. This
means that the price of bread increased by more (in percentage terms) than the price of a
motor car between January and December 2002.

 HOW TO FIND BASE YEAR

A base year is chosen and the index is computed. The price of the fixed basket of goods
and services for each comparison year is then divided by the price of the fixed basket of
goods in the base year. The result is multiplied by 100 to give the relative level of the cost
of living between the base year and the comparison years.

 WHAT SHOULD WE CONSIDER

The base year of a price index series has to be carefully chosen since the base year would
have a considerable influence both on the movement of price relatives of the individual
commodities and on the weighting pattern thus influencing the movement of the Index as a
whole. The considerations that would go into the selection of the base year could be briefly
listed as follows:

i. The base year should be a normal year in respect of production and trade.
Since, a fixed weighting pattern is followed throughout the life of the index, a
Laspeyres, it is necessary that the weighting pattern should represent the
normal weight of commodities in production and trade;
ii. The base year should be a normal year in respect of prices of commodities in
general. The period at least should not be one representing abnormal prices
and their fluctuations;
iii. Reliable price data may be available for the selected base year;
iv. The base year should be as recent as possible so that by the time the revised
series is released it has not outlived its utility;
v. As far as possible, the base year should be aligned with the base year of other
important economic indicators and indices, such as national income series,
other price series, etc. Since most of the important economic indicators are
interactive, proper alignment of the base year will smoothen the jerks in the
movements and will ensure consistency.
Advantages and disadvantages of Paasche and Laspeyres.

Ease of Calculation
Laspeyres Price Index is based upon the baseline quantities only the current year’s prices are
required for the calculation of the index. For the Paasche Price Index then the current year
quantities and prices are required. Laspeyres Price Index is slightly easier to calculate and can
be obtained in situations where the current year’s quantities are unknown.

Relevance
Paasche Price Index uses current quantities so more relevant and topical.
Especially where the quantities may have changed dramatically.

Long series of data

Paasche Price Index has to be recalculated each period new data comes along as the current
period will have changed. Substantial quantity changes then the previously calculated
Paasche Price Indices may take substantially different values from the newly calculated ones
based upon the new current year quantities.
Laspeyres Price Index does not need to be recalculated as the base period remains the same.

In Summary
Paasche Price Index is slightly more relevant better interpretation as uses current quantities
slightly more inconvenient to calculate. If both quantities and prices are readily available then
it is a simple matter to calculate both and the combined index. Substantial differences
between the Laspeyres and Paasche Price Indices then this are conveying information about
the changes in prices and quantities.