(Chapter–09): Indices RISE Quantitative Methods

Chapter-09

INDICES
Index Number
An index number is a device that measures the relative change in one variable or group of variables
with respect to time or place.
Uses of Index Number
• At economic levels, index number can be used to get feel of the economic tendencies,
inflation and deflation.
• In formulating polices, indices can help vouch for any production or trade fluctuations.
• It can also help in exploring the trends prevailing at the market.
• It can also be helpful in determining purchasing powers as well as real income of the people.
Limitations of Index Number
• Index number is an approximate of relative change in prices. It is not accurate
• It is not possible to take entire basket of items for computation of index number. A sample of
representative items are taken. There may be some errors due to the selective items of
sample.
• It is difficult to select a base period because it is difficult to find a normal period free from all
disturbances.
• Assigning weight to different items is a difficult task.
• Quality of the items may not remain constants over the time period of investigation.
• There are large number of formulas for construction of index number. Wrong selection of
formula leads to wrong result.

Note:
• The index number is used as a barometer of inflation/ deflation
• The index number of base period is 100.

Important MCQs

1. The period with which other periods are to be compared is called:

A) Current Period B) Base Period
C) Chain Indices D) None of these

2. The index number is used as the barometer of:

A) Prices B) Quantities
C) Inflation/Deflation D) None of these

Types of Index Number

• Simple Index Number
• Composite Index Number

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Simple Index Number

An index number which is computed for a single variable is called simple index number.
Composite Index Number
An index number which is computed for more the one variable is called composite index number.

Price of Commodity in the Current Year

Price Relative =  100
Price of Commodity in the Base Year
𝑃𝑛
Pon = I =  100
𝑃𝑜
Quantity of Commodity in the Current Year
Quantity Relative = Quantity of Commodity in the Base Year
 100
𝑞𝑛
Qon = I =  100
𝑞𝑜
Price of Commodity in Current Year
Link Relative = Price of Commodity in Immidiate Previous Year  100
𝑃𝑛
L.R =𝑝𝑛−1, 𝑛 =  100
𝑃𝑛−1
L.R of Current Year ×Chain I. No. of Previous Year
Chain Index Number =
100

• pn = p1 = Current year Price

• p0 = Base year Price
• qn = q1 = Current year Quantity
• qo = Base Year Quantity

Example 01:
The following information relates to the price and quality of coffee machines sold over a five year
period.
Year Price (Rs.) Quantity
2011 6500 12178
2012 6800 13493
2013 6900 15149
2014 7200 16287
2015 7500 17101
Compute price and quantity index number taking 2013 as base year.

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Solution:
Year Price (Rs.) Price Index Number
6500
2011 6500  100 = 94.20
6900
6800
2012 6800  100 = 98.55
6900
6900
2013 6900  100 = 100.00
6900
7200
2014 7200  100 = 104.35
6900
7500
2015 7500  100 = 108.69
6900

Year Quantity Quantity Index Number

12178
2011 12178  100 = 80.38
15149
13493
2012 13493  100 = 89.06
15149
15149
2013 15149  100 = 100.00
15149
16287
2014 16287  100 = 107.51
15149
17101
2015 17101  100 = 112.88
15149
Example 02:
Compute chain index number for the following data, and the data is related to the daily wages of
unskilled labourers in Lahore.
Year Wages Link Relative Chain Index Number
2016 46 100 100
51 110.87  100
2017 51  100 = 110.87 = 110.87
46 100
58 113.73  110.87
2018 58  100 = 113.73 = 126.09
51 100
71 122.41 126.09
2019 71  100 = 122.41 = 154.35
58 100
86 121.13  154.35
2020 86  100 = 121.13 = 186.96
71 100

Important MCQs

3. The data given below is available about the price of wheat for the year 2001 to 2005.
Year 2001 2002 2003 2004 2005
Price 85 96 112 130 160
Compute price index number taking 2001 as base year.
A) 100, 112.94, 131.76,152.94, 188.24 B) 100, 102.94, 113.76, 152.94, 158.24
C) 100, 112.94, 111.76, 172.94, 183.24 D) None of these

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4. The price of a juicer machine during the past 5 years is as follows.

Year 20X7 20X8 20Y9 20Y0 20Y1
Price 3700 4500 4800 5000 5300
Compute simple price index number for the above data taking 20X7 as base.
A) 100, 121.62, 129.73, 135.14, 143.24 B) 121.62, 100, 93.75, 90, 84.91
C) 100, 82.22, 77.08, 74, 69.81 D) 82.22, 100, 106.67, 111.11, 117.78

5. Compute chain index number for the following data.

Year 2011 2012 2013 2014 2015
Price 15 19 21 30 37
A) 100, 103.45, 126.09, 135.87, 154.35 B) 100, 110.87, 133.09, 154.35, 166.96
C) 100, 120.87, 132.09, 164.35, 186.96 D) 100, 126.67, 140.01, 200.02, 246.68

Simple Aggregative Price Index

It is the ratio of the sum of prices of commodities in a given year (current year) to the sum of prices
of the same commodities in the base year and expressed the results as a percentage.
Symbolically we have
∑𝑃𝑛
Pon =  100
∑𝑃𝑜
• Pon denotes the simple aggregative price index
• Pn = Sum of prices of commodities for given year
• Po = Sum of prices of commodities for base year
Example 03:
Calculate simple aggregative price index for 2020 when the support prices of agricultural
commodities in rupees per kg in 2010 and 2020 are given below:
Prices
Commodity
2010 2020
Wheat 35 80
Rice 118 205
Potato 20 60
Onion 45 150
P0 = 218  Pn = 495

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Simple Aggregative Price Index

∑𝑃𝑛
Pon =  100
∑𝑃0
495
=  100
218
= 227.06
This indicates that the prices of the above four commodities in 2020 are 127.06% higher than 2010.
Example 04:
Compute simple aggregative price index number taking to 2021 as base period.
Prices
Commodity
2021 2022 2023
A 12 15 15.6
B 3 3.6 3.3
C 5 6 9.7
Solution:
Prices
Commodity
po p1 p2
A 12 15 15.6
B 3 3.6 3.3
C 5 6 9.7
Sum 20 24.6 28.6
Simple aggregative price index for 2021 is 100.
Simple aggregative price index for 2022.
∑𝑃1 24.6
Po1 =  100 =  100 = 123
∑𝑃0 20
Simple aggregative price index for 2023.
∑𝑃2 28.6
Po2 =  100 =  100 = 143
∑𝑃0 20

Important MCQs

6. Calculate the unweighted price index for 1998 when the procurement/ support price of
agricultural commodities in rupees per 40 kg in 1988 and 1998 are given as follows:
Commodity Prices
1988 1998
Wheat 58 160
Rice 118 360
Potato 27 19
Onion 80 84
A) 120.14 B) 220.14
C) 160.35 D) None of these

Weighted Index Number

It is a statistical measure that assigns varying levels of importance or weights to different
components within data set. These weights are used to calculate an aggregate value that reflects
changes or performance in the data with components of greater importance contributing more
significantly to the final index value.

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Laspeyre’s Price Index

 p n q0
Pon =  100
 p 0 q0
Laspeyre’s Quantity Index
 qnp 0
Qon =  100
 q0 p 0
Paasche’s Price Index
 pn qn
Pon =  100
 p 0 qn
Paasche’s Quantity Index
 qnpn
Qon =  100
 q0 p n
Fisher’s Ideal Price Index

 pn q0  pn qn
Pon =  100
 p0 q0  p0 qn

Fisher’s Ideal Quantity Index

 qnp0  qnpn
Qon =  100
 q0 p0  q0 pn

F= L P
• Fisher’s ideal index is a geometric mean of Laspeyre’s and Paasche’s index.
• The denominator in the Laspeyre’s price index does not change from year to year.
• The denominator in the Paasche’s price index has to be recalculated every year to take
account the most recent quantities consumed.
• Laspeyre’s price index tends to overstate inflation.
• Paasche’s price index tends to understate inflation.
• The Laspeyres index which is based on quantities bought in the base year fails to account
for the fact that people will buy less of those items which have risen in price more than others.
• The Paasche index is based on the most recent quantities purchased. This means that it has
a focus which is biased to the cheaper items bought by consumers as a result of inflation.

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Example 05:
Price in Price in Quantity Quantity
Product 2020 2021 in 2020 in 2021 pnq0 p0q0 pnqn p0qn
p0 pn q0 qn
A 5 7 10 8 70 50 56 40
B 12 13 12 10 156 144 130 120
C 15 20 14 9 280 210 180 135
506 404 366 295
Calculate Laspeyre’s Price Index
 p n q0
Pon =  100
 p 0 q0
506
Pon =  100 = 125.25
404
Calculate Paasche’s Quantity Index
 pn qn
Pon =  100
 p 0 qn
366
Pon =  100 = 124.07
295
Calculate Fisher’s Ideal Price Index
 pn q0  pn qn
Pon =  100 or F= L P
 p0 q0  p0 qn

506 366
Pon =  100 = (125.25)(124.07)
404 295
Pon = 124.66 = 124.66
Calculate Laspeyre’s Quantity Index
 qnp 0
Qon =  100
 q0 p 0
295
Qon =  100 = 73.02
404
Calculate Paasche’s Quantity Index
 qnpn
Qon =  100
 q0 p n
366
Qon =  100 = 72.33
506
Calculate Fisher’s Ideal Quantity Index
∑𝑞 𝑝 ∑𝑞 𝑝
Qon =√ ∑𝑞𝑛𝑝0 × ∑𝑞𝑛𝑝𝑛100 or F =√𝐿 × 𝑃
0 0 0 𝑛

295 366
Qon =√ × 100 =√(73.02)(72.33)
404 506

Qon = 72.68 = 72.68

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Example 06:
The Laspeyre’s and Paasche’s price index are 113 and 118 respectively. Calculate the Fisher’s
price index.
Solution:

F= L P
= √113 × 118 = 115.47
Example 07:
The Paasche’s index is 20% higher than Laspeyre’s index and Fisher’s index is 139.54. Computer
Laspeyre’s index.
Solution:
Let L = 100x and P = 120x
F = 139.54

F= L P
139.54 = √100𝑥 × 120𝑥 = 1.2738
So,
L = 100x = 100 (1.2738) = 127.38

Important MCQs

7. If the quantities of the base year are used as weight then which of the following method is used
to calculate the weighted aggregative price index number:
A) Laspeyre’s Method B) Paasche’s Method
C) Fisher’s Method D) All of these

8. If the quantities of the current year are used as weight, then which of the following method is
used to calculate the weighted aggregative price index number:
A) Laspeyre’s Method B) Paasche’s Method
C) Fisher’s Method D) All of these

9. The geometric mean of Laspeyre’s and Paasche’s Index Number is called:

A) Simple Price I.No. B) Marshal Edgeworth’s I.No.
C) Fisher’s Ideal I.No. D) None of these

10. _________ tends to overstate inflation:

A) Laspeyre’s I.No. B) Paasche’s I.No.
C) Fisher’s I.No. D) All of these

11. What is the effect of Paasche’s on inflation?

A) Its understate inflation B) Its overstate inflation
C) No impact D) None of these

12. Which of the following statement is/are correct?

(i) In Laspeyre’s price index, the denominator does not change from year to year.
(ii) In Paasche’s price index, the denominator has to be recalculated every year to take
account of the most recent quantities consumed
A) Both statements are correct B) Both statements are not correct
C) Only statement (i) is correct D) Only statement (ii) is correct

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13. Which of the following statements about Laspeyre’s Price Index is/are correct?
(i) It tends to overstate inflation.
(ii) The denominator does not change from year to year.
A) Only (i) statement is correct B) Both statements are not correct
C) Both statements are correct D) Only statement (ii) is correct

14. Which is the following being correct about Laspeyre’s price index?
A) It has a focus which is biased to the cheaper items bought by consumer as a result of
inflation
B) The denominator in the Laspeyre’s price index has to be recalculated every year to take
account of the most recent quantities consumed.
C) It is based on the most recent quantities purchased
D) It tends to overstate inflation

15. Which of the following is correct about Paasche’s index?

A) It fails to account for the fact that people will buy less of those items which have risen in
prices
B) The denominator in the Paasche’s price index does not change from year to year.
C) It is based on the most recent quantities purchased.
D) It tends to overstate inflation

16. Compute Laspeyre’s Price Index for the following data using 2002 as base:
Ingredients Price in 2002 Price in 2007 Quantity in 2002 Quantity in 2007
A 140 220 40 60
B 120 180 25 50
C 80 110 60 90
A) 147.21 B) 148.51
C) 149.50 D) 146.50

17. If ∑ 𝑝1 𝑞0 = 60, ∑ 𝑝0 𝑞0 = 70.5, ∑ 𝑝1 𝑞1 = 72 and ∑ 𝑝0 𝑞1 = 73, then find Fisher’s Ideal Index
Number.
A) 107.65 B) 91.62
C) 109.15 D) 92.89

Consumer Price Index (CPI)

Consumer price index measures the cost of a consumer basket (goods and services) purchased
by a typical urban family at a point in time as compared to the base year. The basket may include
items of good, clothing, housing, fuels, transportation and medical care.
CPI is used to calculate the purchasing power or cost of living of the concerned group of people or
class. It can also help to identify the periods of inflation and deflation.

∑𝑝𝑛 𝑞0 ∑𝐼𝑊
Pon =  100 Pon =
∑𝑝0 𝑞0 ∑𝑊
Where,
𝑝𝑛
I=  100
𝑝0
W = poqo

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Example 08:
Compute CPI by aggregative expenditure method for the following data.
Commodity Price in 2010 Price in 2011 Quantity in 2010
A 32 40 20
B 10 12 15
C 8 15 7
D 15 20 4
E 12 15 10
F 18 25 2

Solution:
Commodity po pn qo pnqo poqo
A 32 40 20 800 640
B 10 12 15 180 150
C 8 15 7 105 56
D 15 20 4 80 60
E 12 15 10 150 120
F 18 25 2 50 36
1365 1062

∑𝑝𝑛 𝑞0
Pon =  100
∑𝑝0 𝑞0

1365
Pon =  100 = 128.53
1062

Example 09:
Food Rent Clothing Fuel Misc.
Expenses on
35% 15% 20% 10% 20%
Price (2000) 150 30 75 25 10
Price (2001) 145 30 65 23 15
What changes in cost of living the figures of 2001 show as compared to 2000?
Price (2000) Price (2001) 𝒑𝒏
Expanses W = 𝒑𝒐 𝒒𝒐 × 𝟏𝟎𝟎 𝑰𝑾
(𝒑𝒐 ) (𝒑𝒏 ) 𝒑𝒐
Food 35 150 145 97 3395
Rent 15 30 30 100 1500
Clothing 20 75 65 87 1740
Fuel 10 25 23 92 920
Misc. 20 40 45 113 2260
Total 100 - - - 9815
Cost of living for 2001.
∑𝐼𝑊
Pon = ∑𝑊
9815
= 100
= 98.15

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CPI for a single item:

Cost of Market (Consumer)Basket in Current Year
CPI = x 100
Cost of Market (Consumer)Basket in Base Year
Example 10:
A household has following basket of commodities compute CPI taking base year as 2009.
Price of Commodities
Commodities
2009 2010 2011 2012
Eggs 1.90 2.50 2.11 2.00
Milk 1.00 1.50 1.10 1.30
Bread 0.90 0.95 0.90 0.90
Butter 0.55 0.60 0.65 0.65
Meat 1.20 1.12 1.50 1.60
5.55 6.67 6.26 6.45

Year Cost of Basket Consumer Price Index (CPI)

5.55
2009 5.55  100 = 100
5.55
6.67
2010 6.67  100 = 120.18
5.55
6.26
2011 6.26  100 = 112.79
5.55
6.45
2012 6.45  100 = 116.21
5.55
Rate of Inflation / Deflation
The percentage change in the CPI can be used to determine rate of inflation / deflation. If the CPI
increases there is inflation and if the CPI decreases there is deflation.
𝐶𝑃𝐼2 −𝐶𝑃𝐼1
Inflation / Deflation Rate =  100
𝐶𝑃𝐼1
Year Inflation / Deflation
120.18−100
2009 to 2010 100
 100 = 20.18%
112.79−120.18
2010 to 2011 120.18
 100 = –6.15% = (6.15%)
116.21−112.79
2011 to 2012 112.79
 100 = 3.03%

Important MCQs

18. Following Consumer Price Indices (CPI) have been computed taking 20X9 as base year:
Year CPI
20X8 104.98
20X9 100
20Y0 116.19
20Y1 115.11
20Y2 132.01
Yearly Inflation (Deflation) for the above data would be
A) (4.98%), 5.83%, (7.75%), 12.80% B) 4.98%, 6.19%, 8.41%, 14.69%
C) (4.74%), 16.19%, (0.92%), 14.68% D) 4.74%, 6.17%, 8.40%, 14.68%

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19. An increase in price index from 120 to 128 means that the prices have increased by:
A) 8% B) 8.667%
C) 6% D) 6.667%

20. Four year ago the price index of a particular product was 60. If the same index is now 108.
Compute percentage increase in the price of product.
A) 48% B) 80%
C) 58% D) 60%

Purchasing Power of Money

It is the value of a currency expressed in terms of the number of goods or services that one unit of
money can buy.
1
Purchasing power of money =  100
CPI
Gross Domestic Product (GDP)
It is the monetary value of all the final good and services produced within a country in a year.
• Nominal GDP
• Real GDP
• GDP Deflator

Nominal GDP
When GDP of a given year is estimated on the basis of price of the same year, it is called nominal
GDP.

Real GDP
When GDP of a given year is estimated on basis of price of base year, it is called real GDP.

Example 11:
Two years basket of goods is given below.
2019 2020
Commodity
Quantity Price Quantity Price
Eggs 50 1.90 64 2.00
Milk 60 1.00 50 1.50
Bread 55 0.90 60 0.95
Find Nominal GDP for 2020.
2020 Output Value
Commodity
Quantity Price Price  Quantity
Eggs 64 2.00 128
Milk 50 1.50 75
Bread 60 0.95 57
Nominal GDP 260
Find Real GDP for 2020.
2019 2020 Output Value
Commodity
Price Quantity P0  Qn
Eggs 1.90 64 121.6
Milk 1.00 50 50
Bread 0.90 60 54
Real GDP 225.6
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
GDP Deflator =  100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
260
GDP Deflator =  100 = 115.24  115
225.6

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