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Index numbers

The numerical results of a calculation based on a basket of goods can get a little messy. The simplified example in [link] has only three goods and the prices are in even dollars, not numbers like 79 cents or $124.99. If the list of products was much longer, and more realistic prices were used, the total quantity spent over a year might be some messy-looking number like $17,147.51 or $27,654.92.

To simplify the task of interpreting the price levels for more realistic and complex baskets of goods, the price level in each period is typically reported as an index number    , rather than as the dollar amount for buying the basket of goods. Price indices are created to calculate an overall average change in relative prices over time. To convert the money spent on the basket to an index number, economists arbitrarily choose one year to be the base year    , or starting point from which we measure changes in prices. The base year, by definition, has an index number equal to 100. This sounds complicated, but it is really a simple math trick. In the example above, say that time period 3 is chosen as the base year. Since the total amount of spending in that year is $107, we divide that amount by itself ($107) and multiply by 100. Mathematically, that is equivalent to dividing $107 by 100, or $1.07. Doing either will give us an index in the base year of 100. Again, this is because the index number in the base year always has to have a value of 100. Then, to figure out the values of the index number for the other years, we divide the dollar amounts for the other years by 1.07 as well. Note also that the dollar signs cancel out so that index numbers have no units.

Calculations for the other values of the index number, based on the example presented in [link] are shown in [link] . Because the index numbers are calculated so that they are in exactly the same proportion as the total dollar cost of purchasing the basket of goods, the inflation rate can be calculated based on the index numbers, using the percentage change formula. So, the inflation rate from period 1 to period 2 would be

99.5 – 93.4 93.4  =  0.065  =  6.5%

This is the same answer that was derived when measuring inflation based on the dollar cost of the basket of goods for the same time period.

Calculating index numbers when period 3 is the base year
Total Spending Index Number Inflation Rate Since Previous Period
Period 1 $100 100 1.07  =  93.4
Period 2 $106.50 106.50 1.07  =  99.5 99.5 – 93.4 93.4  =  0.065  =  6.5%
Period 3 $107 107 1.07  =  100.0 100 – 99.5 99.5  =  0.005  =  0.5%
Period 4 $117.50 117.50 1.07  =  109.8 109.8 – 100 100  =  0.098  =  9.8%

If the inflation rate is the same whether it is based on dollar values or index numbers, then why bother with the index numbers? The advantage is that indexing allows easier eyeballing of the inflation numbers. If you glance at two index numbers like 107 and 110, you know automatically that the rate of inflation between the two years is about, but not quite exactly equal to, 3%. By contrast, imagine that the price levels were expressed in absolute dollars of a large basket of goods, so that when you looked at the data, the numbers were $19,493.62 and $20,009.32. Most people find it difficult to eyeball those kinds of numbers and say that it is a change of about 3%. However, the two numbers expressed in absolute dollars are exactly in the same proportion of 107 to 110 as the previous example. If you’re wondering why simple subtraction of the index numbers wouldn’t work, read the following Clear It Up feature.

Questions & Answers

what is elastic
fadoju Reply
how is equilibrium defined in financial market?
infinity Reply
what is the definition of money
infinity
Money is define as anything that is generally acceptable as a means of exchange nd settlement of dept
Simeon
how do choices end up determining what, how and for whom goods and services are produced
Ayesha Reply
there are 10 000 seats available for the Wimbledon tennis Championships. the price per ticket is fixed by the organisers. the supply of seats is thus: A. completely elastic B. completely inelastic C. elastic D. unitary elastic E. elastic which option is the answer?
Esihle Reply
what is international trade
Naomi Reply
the trade between two or more countries outside the territory of own country
Mukeem
it's an international trade
Ivan
Multilateral trade it is
Antony
how do monopolistic firm make profit in the short run and long run
Ediga Reply
oligopolistic competition is known to have a kinked demand curve .why there is such a tease my in oligopolistic form only
Ediga
please can anyone help me in econs
Oppong
Manuel in which context
Daizy
please in utility
Oppong
what is demand ?
Tonight Reply
The amount of some goods or services consumers need to purchase
Adu
The amount of goods or services that consumers are willing and can afford to purchase.
Ivan
it is goods and services consumers are willing and able to buy at given price over a given period of time
Rebecca
as quantity of good and service that a consumer is willing and able to purchase at a given price and at the particular market price.
MOHAMMED
The amount of goods and services consumers are able and willing to buy and pay for at a given price and at given point in time.
Solomon
refers to the quantity of goods and services that customers are willing and able to purchase at various prices over a period of time
Ryt
what are subsidies
Yaya Reply
how do trade unions deal with subsidies
Yaya
bro can you explain decision making
WhatsApp
Decision making is a process to use your limited resources for best productive purpose.
Dipam
explain why an increase in national income may not always lead to improvement in economic wellbeing of all the citizens?
Mendo
How many types of labour do we have pls
ROA
two
nabil
skilled and unskilled labour
nabil
Thanks 🙏
ROA
what are the factors that affects efficiency of labour ?
nabil
What are tools of economics analysis
Adu
Adu Tumwah,,, The tools of economics analysis are; Charts, graphs, equations, table, arithemetic mean, etc.
Dennis
Subsidies are payments made by the government to the producers of goods and services
Daizy
what is the marginal revenue if p=10-2q
Karen Reply
what's the difference between demand goods and supply gooda
Spiff Reply
why is 2% the optimal inflation rate in many countries
Spiff
why is 2% the optimal inflation rate in many countries
Spiff
what's inflation
Thando Reply
a general rise in the prices of services and goods in a particular country
Spiff
why is 2% the optimal inflation rate in many countries?
amina
resulting in a fall in the value of money,,
Spiff
for example
Spiff
Inflation is the continuous rise of price of goods and services in a nation
Oluchi
persistent increase in the general price level
Anyere
what will the effective demand if inflation is constant and real wage is less then money wage ?
Vipul Reply
to start
Dennis
to start with your question i think we have to break it down into key words, and they effective demand ,inflation and real wages ... Ok when we say demand is effective we mean the demand is backed up by capital .. it is backed up by the ability to pay for the good/commodity demanded for
Dennis
in other hand inflation is the persistent rise of goods and services in and particular country's economy
Dennis
so what is real wages it means the amount paid to labour for a particular work done
Dennis
money wage is the money/capital paid to a worker
Dennis
knowing this terms you can be able to answer your question....
Dennis
What is monopoly
Oluchi Reply
I believe that a market is monopolistic if there is no competition. in other words, a given company is the only one offering the product/service.
amina
am a fan of monopoly
Okeke
it is correct
Spiff
and in other word,,, is a thing that belongs to one person or group that another people will not able to share
Spiff
a single seller and large number of consumer
Vipul
A monopoly is a firm that is the sole producer of a good or service for which there are no close substitutes. It exist because of barriers to entry. The barriers can be legal or natural.
Dennis
Ok
Oluchi
give tree difference between economic good and free good
Gideon Reply
economic goods produced by man efforts and free goods are free by nature
Kobwa
What are tools of economics analysis
Adu
economics provides tools to know our better desire and how to get maximum utility and right way right time decission power.
Inno
economic good are related to income to fullfill satisfaction and free goods are natural resourses like sunshine rain air water from earth e.t.c
Inno
graphs,pie chart,histograms,tables,curves,etc.
nabil
why do government sometimes impose indirect taxes rather than direct taxes.
nabil
just five points with no explanations
nabil
what is want
Wasila Reply
anything just come from your heart
domingo
no matter how much you give
domingo
is what you desire to have
Tsai
their the human desire it's need(s).
Gideon
YES
Erik
like medicine food etc
domingo

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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