Index Numbers

Chapter 17

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Learning Objectives
LO17-1 Compute and interpret a simple, unweighted
index
LO17-2 Compute and interpret an unweighted aggregate
index
LO17-3 Compute and interpret a weighted aggregate
index
LO17-4 List and describe special-purpose indexes
LO17-5 Apply the Consumer Price Index

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Index Numbers

INDEX NUMBER A number that expresses the relative change in price,

quantity, or value compared to a base period.

 The major characteristics of an index are

 It is a percentage, but the percent sign is usually
omitted
 It has a base period
 The reasons for computing an index are
 It facilitates the comparison of unlike series
 If the numbers are very large, often it is easier to
comprehend the change of the index rather than the
change in numbers
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Hourly Wages Index Example

According to the Bureau of Labor Statistics, in 2000 the average hourly earnings of
production workers was $14.02. In March 2016, it was $21.37. What is the index of
hourly earnings of production workers for March 2016 based on 2000 data?

Average hourly earnings in 2016 $21.37

P= (100) = (100) = 152.43
Average hourly earnings in 2000 $14.02
Thus, the hourly earnings in 2016 compared to 2000 were 152.43%. This means
there was a 52.43% increase in hourly earnings during the period, found by
152.43 – 100.0 = 52.43

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Population Index Example

An index can also compare one item to another. The population of the Canadian
province of British Columbia in 2014 was 4,657,947, and for Ontario it was
13,730,187. What is the population index of British Columbia compared to Ontario?

The index of population for British Columbia is 33.9 found by:

Population of British Columbia 4,657,947
P= (100) = 13,730,187 (100) = 33.9
Population of Ontario
The population of British Colombia is 33.9% (about one-third) of the population of
Ontario, or another way to say that is the population of British Columbia is 66.1%
less than the population of Ontario (100 – 33.9 = 66.1)

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Airport Index Example
The following chart shows the number of passengers (in millions) for the 10 busiest
airports in the United States in 2014. Use the McCarran International Airport in
Las Vegas as the base. What is the index for the other airports compared to
Las Vegas?

To find the 10 indexes,

divide the passengers for
Las Vegas into the
passengers for the other 9
airports. So the index for
Atlanta is 224.2 found by
(96.2/42.9)· (100) = 224.2

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E-Commerce Sales Index Example
 Converting data to indexes makes it easier to see the
trend in a series of very large numbers
 For example
 US retail e-commerce sales in 2014 were $304,913,000
 In 2010, e-commerce sales were $168,895,000
 An increase of $136,018,000

2014 e−commerce sales $304,913,000

Index = (100) = (100) = 180.5
2010 e−commerce sales $168,895,000

This means 2014 sales increased 80.5% in the four-year period.

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Construction of Index Numbers
 To calculate a simple price index P, using 100 as the base
value for any given year, use the formula below

Suppose the price of a fall weekend package at Tryon Mountain Lodge in western
North Carolina in 2000 was $450. The price rose to $795 in 2017. What is the price
index for 2017 using 2000 as the base period and 100 as the base value?
P $795
P = P t (100) = (100) = 176.7
0 $450
The fall weekend package increased 76.7% from 2000 to 2017.

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Converting to Indexes using Different Base
Periods
Below is a table for prices of a Benson Automatic Stapler, Model 3, converted to
indexes using three different base periods. First, a single year (2005) is used and
each year’s price is divided by 20.
Next, two years (2005-2006) are used as the base; the base price of the stapler
would be $21, found by averaging the price of the stapler in the two years
(20+22)/2 = $21and then dividing each year’s price by 21.
Finally, the prices $20, $22, $23 are averaged if we use three years (2005-2007) as
the base and then each year’s price is divided by 21.67. to obtain the price index.

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Unweighted Indexes
 In an unweighted index, we do not consider the quantities
 We may wish to combine several related items and
compare this group of items in two different time periods
 An index for items related to owning and operating an
automobile (tires, oil changes, and gasoline)
 An index for items related to expenses of a college
student (books, tuition, housing, meals, entertainment)
 In the simple average of price indexes, we add the simple
indexes for each item and divide by the number of items

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Simple Average of Price Indexes Example
This table reports the prices for several food items in 2003 and 2015. We
would like to develop an index for this food group for 2015 using 2003 prices
as the base. This is written 2003=100
First, we use formula 17-1 to compute the simple index for each food item.
P 1.440
For instance, the index for bread, P = P t (100) = 1.042 (100) = 138.2
0
Now use formula 17-2 to compute the percentage change in the group.
ΣP 138.2+ …. +161.0 893.4
P = ni = = 6 = 148.9
6
The mean price of food increased 48.9% from 2003 to 2015.

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Simple Aggregate Price Index
 In a simple aggregate price index, the price of the items in
the group are totaled for both periods and compared

The simple aggregate index for food for food items on the previous slide is found
by dividing the sum of prices in 2015 by the sum of the prices in 2003.
ΣP $15.806
P = ΣP t (100) = (100) = 148.3
0 $10.661
This means that the aggregate group of prices had increased 48.3% from 2003 to
2015.

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Weighted Indexes: Laspeyres Method
 In a weighted index, the quantities are considered
 In the Laspeyres method, base period quantities are used
in both the base period and the given period

 Advantage of the Laspeyres method

 Only quantity data from the base period is used which
allows for more meaningful comparison over time
 Disadvantage
 Does not reflect changes in buying patterns over time
 It may overweight goods whose prices increase

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Laspeyres Price Index Example
First we determine the total amount spent for the six items in the base period, 2003.
To find this value, multiply the base period (2003) price for bread $1.042 by the base
period quantity of 50. The result is $52.10. Continue that for all items and total the
result. The base period total is $493.86.
The current year total is computed in a similar fashion. For bread, we multiply the
quantity in 2003 by the price of bread in 2015, 50 times $1.440 is $72.00. We make the
same calculation for the other items and total to get $683.68.
Σp q $683.68
P = Σp t qt (100) = (100) = 138.44
0 t $493.86

We conclude
the price of
this group of
items has
increased
38.44% from
2003 to 2015.
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Weighted Indexes: Paasche Method
 In the Paasche method, current period quantities are used

 Advantage of Paasche method

 Current buying habits are reflected
 Disadvantage
 It requires quantity data for the current year and it
tends to overweight goods whose prices have declined
 It requires the product of prices and quantities to be
recomputed each year

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Paasche Price Index Example
The following table shows the calculations to determine the Paasche index.
Σp q $790.37
P = Σp t qt (100) = (100) = 136.70
0 t $578.19
This result indicates that there has been an increase of 36.7% in the price of this
“market basket” of goods between 2003 and 2015.

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Fisher’s Ideal Index
 Fisher’s ideal index is the geometric mean of the
Laspeyres and Paasche indexes

Determine Fisher’s ideal index for the data in Table 17-3 using our results
from the earlier examples.

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

= (138.44)(136.70)=137.57
So, Fisher’s ideal index is 137.57

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Value Index
 A value index uses both base period and current period
prices and quantities

The prices and quantities sold at the Waleska Clothing Emporium for ties, suits,
and shoes for May 2000 and May 2017 are given in the table on the left.
What is the index of value for May 2017 using May 2000 as the base period?
Total sales in May 2017 were $10,600 and in 2000 is $9,000.
Σp q $10,600
V = Σp tqt (100) = (100) = 117.8
0 0 $9,000
The value of apparel sales increased 17.8% from May 2000 to May 2017.

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Special-Purpose Indexes
 Here is an example of using an index as a measure of
general business activity for northwest US
The Seattle Chamber of Commerce wants to develop a measure of general business
activity. It will be called the General Business Activity Index of the Northwest and will
include department store sales (40%), regional employment (30%), freight car loadings
(10%), and exports from Seattle harbor (20%).

Business activity has

increased 57.0%
from 2005 to 2010
and 57.1% from
2005 to 2016.

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 Consumer Price Index

The BLS reports

this index
monthly. It
describes the
changes in prices
from one period
to another for a
“market basket”
of goods and
services.

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Producer Price Index

The PPI reflects the prices

of over 3,400 commodities
and price data is collected
from the sellers. The PPI is
a Laspeyres type index.

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 Dow Jones Industrial Average (DJIA)

This is an index of
stock prices. It
represents the prices
of 30 specific stocks
of large publicly
owned U.S. based
companies.

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Consumer Price Index (CPI)
 Prices are collected on about 80,000 items monthly from
retail stores, service establishments, rental units, and
doctors offices
 The CPI is often used to show the rate of inflation in the
United States
 It is reported monthly by the U.S. Bureau of Labor
Statistics
 The current base period is 1982-84
 There are two indexes, the CPI-U and the CPI-W
 The CPI is used to compute “real” income and purchasing
power and to adjust pensions and tax brackets
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Real Income
Suppose Ms. Watts earned $20,000 per year in the base period of 1982, 1983, and
1984. She has a current income of $40,000. Note that although her money
income has doubled since the base period of 1982-84, the prices she pays for
food, gasoline, clothing, and other items has also doubled. Compute her real
income.

Ms. Watts purchasing power (real income) has remained the same at $20,000.

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Deflating Sales
The sales of Hill Enterprises, a small injection molding company in upstate New
York, increased from 1982 to 2015. The owner, Harry Hill, realizes that the price
of raw materials used in the production process has also increased, so Mr. Hill
wants to deflate sales to account for the increase in raw materials. What are the
deflated sales for 1990, 1995, 2000, 2005, 2010, and 2015 expressed in constant
1982 dollars?

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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?

1 1
Purchasing power of dollar = CPI (100) = 200.0 (100) = $0.50

The CPI of 200 indicates that prices have doubled from the years 1982-84 to
this month. Thus, the purchasing power of the dollar has been cut in half.
That is, a 1982-84 dollar is only worth 50 cents this month.

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