Chapter 9

Index numbers

Outcome

By the end of this session you should be able to:

 calculate indices for price inflation and national income growth using either base
or current weights and use indices to deflate a series

and answer questions relating to these areas.

The underpinning detail for this chapter in your Integrated Workbook can be
found in Chapter 9 of your Study Text

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Chapter 9

Overview

Basics

INDEX NUMBERS

Price Indices Quantity indices

Inflation

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 Index numbers

Basics

1.1 Introduction

 Index numbers measure how a group of related commercial quantities vary,

usually over time

1.2 Definition

Value in any given year

 Index number = × 100
Value in base year

1.3 Interpretation

 An index of 113 means there has been an increase of 13% since the base year

 An index of 85 means there has been a decrease of 15% since the base year

 If an index goes up from 120 to 135, the % increase is (135/120) – 1 = 0.125 or

12.5%. You cannot just subtract the indices.

1.4 Choice of base year

 Needs to be a typical year

 May need changing if comparison is out of date

1.5 Changing base year

Old index number using original base year

 New Index number = × 100
Old index number at new base year
 This is also used when splicing chains of index numbers together

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Question 1
By calculating the index numbers, you are demonstrating the maths skill
of working out percentages of amounts and expressing one amount as a
percentage of another.

Basic index calculation

Express the following data with 2012 as the base year.

Year 2012 2013 2014 2015 2016

Value 153 168 177 181 184

2012 = 153/153 × 100 = 100

2013 = 168/153 × 100 = 109.8

2014 = 177/153 × 100 = 115.7

2015 = 181/153 × 100 = 118.3

2016 = 184/153 × 100 = 120.3

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Question 2
Changing base year

An index has been created with the following values, expressed with a base
year of 2012.

Year 2012 2013 2014 2015 2016

Value 100 109.8 115.7 118.3 120.3

Amend the index figures so that the base year is 2015.

2012 = 100/118.3 × 100 = 84.5

2013 = 109.8/118.3 × 100 = 92.8

2014 = 115.7/118.3 × 100 = 97.8

2015 = 118.3/118.3 × 100 = 100

2016 = 120.3/118.3 × 100 = 101.7

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Question 3
By combining the series of index numbers, you are demonstrating the
maths skill of working out percentages of amounts and expressing one
amount as a percentage of another.

Combining series

Two indices have been created for the same values. The first has a base year
of 2010 and the second has a base year of 2013. Combine both series with a
base year of 2013.

Series 1:

Year 2010 2011 2012 2013

Value 100 105 109 115

Series 2:

Year 2014 2015 2016 2017

Value 106 110 113 117

The series 2 figures already have a base year of 2013 so do not need
amending. The calculations for the series 1 figures are:

2010 = 100/115 × 100 = 87.0

2011 = 105/115 × 100 = 91.3

2012 = 109/115 × 100 = 94.8

2013 = 115/115 × 100 = 100

Illustrations and further practice

Now read illustrations 1 to 4 and try TYUs 1 to 5 from Chapter 9

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Price indices

2.1 Simple price indices

 For a single product

Price in any given year P

 Price index = × 100 = 1 × 100
Price in base year P0

2.2 Relative price indices

 For a collection (“basket”) of products

∑ [w×(P
 Relative price index = 1 /P0 )] ×100
∑w

 “W”s are weights – e.g. typically quantities produced or consumed

 Weights can be derived from quantities in the base year (“base weighted”) or
current year (“current weighted”)

2.3 Choice of weighting

Current Base

 reflect shifts away from goods with  does not do this and hence
high price rises exaggerates inflation.

 current quantities can be very  Simpler

difficult to obtain

 More costly and time-consuming to  Cheaper

calculate

 Difficult to compare many years  Index for each year can be

compared with every other

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Question 4
Simple price index

Express a price of $99 in 2015 as an index with a base of 2012 when the price
was $80.

Price in any given year P1

Price index = × 100 = × 100
Price in base year P0

2015 index = $99/$80 × 100 = 123.75

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Question 5
By calculating the relative price index, you are developing the skill of
analysis.

Relative price index

A manager wishes to index the prices of four of its products between last year
as the base year and this year’s prices. The price and quantity information is as
follows:
Last year This year
Product Price Quantity Price Quantity
($) (units) ($) (units)
A $10.00 60 $10.60 63
B $8.00 175 $8.80 189
C $17.00 250 $19.55 255
D $25.00 1,000 $25.75 1,100
Calculate the base weighted price index using quantities as the weighting.

Step 1 – calculate the price relative (P1/P0) for each product:

Product P1/P0
A 1.06
B 1.10
C 1.15
D 1.03

Step 2 – determine the weightings and apply them to the price relatives:
Product P1/P0 Weighting P1/P0 ×
weighting
A 1.06 60 63.6
B 1.10 175 192.5
C 1.15 250 287.5
D 1.03 1,000 1,030.0

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Step 3 – total the weightings and the P1/P0 × weightings columns and use the
relative price index formula to complete the calculation:
Product P1/P0 Weighting P1/P0 ×
weighting
A 1.06 60 63.6
B 1.10 175 192.5
C 1.15 250 287.5
D 1.03 1,000 1,030.0
1,485 1,573.60

∑ [w× (P1 /P0 )]

Relative price index = ×100
∑w

Index = 1,573.60 / 1,485 × 100 = 106.0

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Question 6
Relative price index

A manager wishes to index the prices of four of its products between last year
as the base year and this year’s prices. The price and quantity information is as
follows:
Last year This year
Product Price Quantity Price Quantity
($) (units) ($) (units)
A $10.00 60 $10.60 63
B $8.00 175 $8.80 189
C $17.00 250 $19.55 255
D $25.00 1,000 $25.75 1,100
Calculate the current weighted price index using values as the weighting.

Step 1 – calculate the price relative (P1/P0) for each product:

Product P1/P0
A 1.06
B 1.10
C 1.15
D 1.03

Step 2 – determine the weightings and apply them to the price relatives:
Product P1/P0 Weighting Weighting P1/P0 ×
calculation weighting
A 1.06 10.6 × 63 667.80 707.868
B 1.10 8.8 × 189 1,663.20 1,829.52
C 1.15 19.55 × 255 4,985.25 5,766.0375
D 1.03 25.75 × 1,100 28,325.00 29,174.75

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Step 3 – total the weightings and the P1/P0 × weightings columns and use the
relative price index formula to complete the calculation:
Product P1/P0 Weighting Weighting P1/P0 ×
calculation weighting
A 1.06 10.6 × 63 667.80 707.868
B 1.10 8.8 × 189 1,663.20 1,829.52
C 1.15 19.55 × 255 4,985.25 5,733.0375
D 1.03 25.75 × 1,100 28,325.00 29,174.75
35,641.25 37,445.1755

∑ [w× (P1 /P0 )]

Relative price index = ×100
∑w

Index = 37,445.1755 / 35,641.25 × 100 = 105.1

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Quantity indices

3.1 Simple quantity indices

 For a single product

Quantity in any given year Q

 Quantity index = × 100 = 1 × 100
Quantity in base year Q0

3.2 Relative quantity indices

 For a collection (“basket”) of products

∑ [w×(Q
 Relative quantity index = 1 /Q0 )] × 100
∑w

 “W”s are weights – e.g. typically prices of products

 Weights can be derived from prices in the base year (“base weighted”) or
current year (“current weighted”)

3.3 Aggregate quantity indices

∑ w×Q
 Aggregate quantity index = 1 × 100
∑ w×Q
0

Question 7
If the quantity of a product sold has risen from 1,200 units in 2012 to 1,400 units
in 2016, express the units sold in 2012 as an index with a base year of 2016.

Quantity in any given year Q1

Quantity index = × 100 = × 100
Quantity in base year Q0

2012 index = 1,200/1,400 × 100 = 85.7

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Question 8
By calculating the relative price index, you are developing the skill of
analysis.

Relative quantity index

A manager wishes to index the quantities of four of their company’s products

between last year as the base year and this year’s quantities. The price and
quantity information is as follows:
Last year This year
Product Price Quantity Price Quantity
($) (units) ($) (units)
A $10.00 60 $10.60 63
B $8.00 175 $8.80 189
C $17.00 250 $19.55 255
D $25.00 1,000 $25.75 1,100
Calculate the current weighted quantity index using prices as the weighting.

Step 1 – calculate the quantity relative (Q1/Q0) for each product:

Product Q1/Q0
A 1.05
B 1.08
C 1.02
D 1.1

Step 2 – determine the weightings and apply them to the quantity relatives:
Product Q1/Q0 Weighting Q1/Q0 ×
weighting
A 1.05 $10.60 11.13
B 1.08 $8.80 9.504
C 1.02 $19.55 19.941
D 1.1 $25.75 28.325

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Step 3 – total the weightings and the Q1/Q0 × weightings columns and use the
relative quantity index formula to complete the calculation:
Product Q1/Q0 Weighting Q1/Q0 ×
weighting
A 1.05 $10.60 11.13
B 1.08 $8.80 9.504
C 1.02 $19.55 19.941
D 1.1 $25.75 28.325
$64.70 68.90

∑ [w× (Q1 /Q )]
Relative quantity index = ×100
∑w

Index = 68.90 / 64.70 × 100 = 106.5

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Question 9
By calculating the relative price index, you are developing the skill of
analysis.

Aggregate quantity index

A manager wishes to index the quantities of four of their company’s products

between last year as the base year and this year’s quantities. The price and
quantity information is as follows:
Last year This year
Product Price Quantity Price Quantity
($) (units) ($) (units)
A $10.00 60 $10.60 63
B $8.00 175 $8.80 189
C $17.00 250 $19.55 255
D $25.00 1,000 $25.75 1,100
Calculate the aggregate quantity index using current year prices as the
weighting.

Step 1 – calculate values for w × Q1 and w × Q0 and total them:

Product w × Q1 w × Q0
A 667.80 636.0
B 1,663.20 1,540.0
C 4,985.25 4,887.5
D 28,325.00 25,750.0
35,641.25 32,813.50
Step 2 – use the aggregate index formula to complete the calculation:
∑ w× Q1
Aggregate quantity index = × 100
∑ w ×Q0

Index = $35,641.25/$32,813.50 × 100 = 108.6

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Illustrations and further practice

Now read illustration 5 and try TYUs 6 to 9 from Chapter 9

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Inflation

4.1 Terminology

 When describing cash flows it is important to clarify whether inflation is included

in the figures.

'Money’ cash flows  include predicted inflation and other price rises

 they are the actual cash flows that take place

 e.g. If I am awarded a 3% pay rise, then my gross

salary will increase by 3% in money terms

‘Real’ cash flows  have had general inflation taken out of them

 If general inflation is 3% per annum, then a 3% pay

rise leaves me no better off in real terms

 If inflation is only 2% then I am approximately 1%

better off in real terms

4.2 Switching between money and real rate indices

 Real index = money index/inflation index

4.3 UK Inflation

 RPI and CPI – both based on baskets of goods

 Fixed quantity price indices

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Question 10
By calculating the relative price index, you are developing the skill of
analysis.

Inflation

The average salary of a group of manual factory workers has been tracked for a
number of years as follows, along with the consumer prices index (CPI) figures
for those periods:
Year Salary ($) CPI value
2012 9,000 110
2013 9,200 114
2014 9,350 117
2015 9,500 121
2016 9,700 126
Recalculate each year’s salary as though it were expressed in 2016 prices.
2012 $9,000 × 126/110 = $10,309
2013 $9,200 × 126/114 = $10,168
2014 $9,350 × 126/117 = $10,069
2015 $9,500 × 126/121 = $9,893
2016 $9,700
Salaries for these workers have not been keeping up with inflation

Illustrations and further practice

Now read illustration 6 and try TYUs 10 to 13 from Chapter 9

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You should now be able to answers all the questions from chapter 9 of the
Study Text and questions 180 – 191 from the Exam Practice Kit.

For further reading, visit Chapter 9 from the Study Text.

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Answers

Question 1
2012 = 153/153 × 100 = 100

2013 = 168/153 × 100 = 109.8

2014 = 177/153 × 100 = 115.7

2015 = 181/153 × 100 = 118.3

2016 = 184/153 × 100 = 120.3

Question 2
2012 = 100/118.3 × 100 = 84.5

2013 = 109.8/118.3 × 100 = 92.8

2014 = 115.7/118.3 × 100 = 97.8

2015 = 118.3/118.3 × 100 = 100

2016 = 120.3/118.3 × 100 = 101.7

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Question 3
The series 2 figures already have a base year of 2013 so do not need
amending. The calculations for the series 1 figures are:

2010 = 100/115 × 100 = 87.0

2011 = 105/115 × 100 = 91.3

2012 = 109/115 × 100 = 94.8

2013 = 115/115 × 100 = 100

Question 4
Price in any given year P1
Price index = × 100 = × 100
Price in base year P0

2015 index = $99/$80 × 100 = 123.75

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Question 5
Step 1 – calculate the price relative (P1/P0) for each product:
Product P1/P0
A 1.06
B 1.10
C 1.15
D 1.03

Step 2 – determine the weightings and apply them to the price relatives:
Product P1/P0 Weighting P1/P0 ×
weighting
A 1.06 60 63.6
B 1.10 175 192.5
C 1.15 250 287.5
D 1.03 1,000 1,030.0
Step 3 – total the weightings and the P1/P0 × weightings columns and use the
relative price index formula to complete the calculation:
Product P1/P0 Weighting P1/P0 ×
weighting
A 1.06 60 63.6
B 1.10 175 192.5
C 1.15 250 287.5
D 1.03 1,000 1,030.0
1,485 1,573.60

∑ [w× (P1 /P0 )]

Relative price index = ×100
∑w

Index = 1,573.60 / 1,485 × 100 = 106.0

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Question 6
Step 1 – calculate the price relative (P1/P0) for each product:
Product P1/P0
A 1.06
B 1.10
C 1.15
D 1.03

Step 2 – determine the weightings and apply them to the price relatives:
Product P1/P0 Weighting Weighting P1/P0 ×
calculation weighting
A 1.06 10.6 × 63 667.80 707.868
B 1.10 8.8 × 189 1,663.20 1,829.52
C 1.15 19.55 × 255 4,985.25 5,766.0375
D 1.03 25.75 × 1,100 28,325.00 29,174.75
Step 3 – total the weightings and the P1/P0 × weightings columns and use the
relative price index formula to complete the calculation:
Product P1/P0 Weighting Weighting P1/P0 ×
calculation weighting
A 1.06 10.6 × 63 667.80 707.868
B 1.10 8.8 × 189 1,663.20 1,829.52
C 1.15 19.55 × 255 4,985.25 5,733.0375
D 1.03 25.75 × 1,100 28,325.00 29,174.75
35,641.25 37,445.1755

∑ [w× (P1 /P0 )]

Relative price index = ×100
∑w

Index = 37,445.1755 / 35,641.25 × 100 = 105.1

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Question 7
Quantity in any given year Q1
Quantity index = × 100 = × 100
Quantity in base year Q0

2012 index = 1,200/1,400 × 100 = 85.7

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Question 8
Step 1 – calculate the quantity relative (Q1/Q0) for each product:
Product Q1/Q0
A 1.05
B 1.08
C 1.02
D 1.1

Step 2 – determine the weightings and apply them to the quantity relatives:
Product Q1/Q0 Weighting Q1/Q0 ×
weighting
A 1.05 $10.60 11.13
B 1.08 $8.80 9.504
C 1.02 $19.55 19.941
D 1.1 $25.75 28.325
Step 3 – total the weightings and the Q1/Q0 × weightings columns and use the
relative quantity index formula to complete the calculation:
Product Q1/Q0 Weighting Q1/Q0 ×
weighting
A 1.05 $10.60 11.13
B 1.08 $8.80 9.504
C 1.02 $19.55 19.941
D 1.1 $25.75 28.325
$64.70 68.90

∑ [w× (Q1 /Q )]
Relative quantity index = ×100
∑w

Index = 68.90 / 64.70 × 100 = 106.5

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Question 9
Step 1 – calculate values for w × Q1 and w × Q0 and total them:
Product w × Q1 w × Q0
A 667.80 636.0
B 1,663.20 1,540.0
C 4,985.25 4,887.5
D 28,325.00 25,750.0
35,641.25 32,813.50
Step 2 – use the aggregate index formula to complete the calculation:
∑ w× Q1
Aggregate quantity index = × 100
∑ w ×Q0

Index = $35,641.25/$32,813.50 × 100 = 108.6

Question 10
2012 $9,000 × 126/110 = $10,309
2013 $9,200 × 126/114 = $10,168
2014 $9,350 × 126/117 = $10,069
2015 $9,500 × 126/121 = $9,893
2016 $9,700
Salaries for these workers have not been keeping up with inflation

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