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What Is The Laspeyres Price Index?

The Laspeyres Price Index is a consumer price index that measures changes in prices of goods and services relative to a base period. It uses quantities from the base period, so only price changes over time are captured. This makes it easy to calculate but prone to overstating inflation. In the example given, the Laspeyres Price Index was 100 for the base year 0, 128.23 for year 1, and 123.53 for year 2, showing price increases over those periods according to the index.

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102 views4 pages

What Is The Laspeyres Price Index?

The Laspeyres Price Index is a consumer price index that measures changes in prices of goods and services relative to a base period. It uses quantities from the base period, so only price changes over time are captured. This makes it easy to calculate but prone to overstating inflation. In the example given, the Laspeyres Price Index was 100 for the base year 0, 128.23 for year 1, and 123.53 for year 2, showing price increases over those periods according to the index.

Uploaded by

jbalaji47
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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What is the Laspeyres Price Index?

The Laspeyres Price Index is a consumer price index used to measure


the change in the prices of a basket of goods and services relative to a
specified base period weighting. Developed by German economist
Etienne Laspeyres, the Laspeyres Price Index is also called the base
year quantity weighted method.

Understanding the Laspeyres Price Index

The Laspeyres Price Index is a price index used to measure the


economy’s general price level and cost of living, and to
calculate inflation. The index commonly uses a base year figure of 100,
with periods of higher price levels shown by an index greater than 100
and periods of lower price levels by indexes lower than 100.

A key differentiator between the Laspeyres Price Index and other


indices (Paasche Price Index, Fisher Price Index, etc.) is that it uses
weights taken from a base period.

The numerator is simply the total expenditures for all items at the
observation period using base quantities, and the denominator is the
total expenditures for all items at the base period using base
quantities. Therefore, the Laspeyres Price Index can be more easily
understood when rewritten as follows:

Index Example

The following information regarding the change in the prices and


quantities of each individual good in a hypothetical economy is
provided. Determine the Laspeyres Price Index for Year 0, Year 1, and
Year 2, using Year 0 as the base year.

  Item   Year 0   Year 1   Year 2

Good A     $5     $10      $7

Good B    $10     $12     $13

Good C    $20     $25     $24

  Item   Year 0   Year 1   Year 2

Good A     100     125     150

Good B     200     225     250

Good C     300     325     350

Using the formula for the Laspeyres Price Index:

 
 

Therefore, the price indexes were as follows for each year:

 Year 0 (Base Year) = 100


 Year 1 = 128.23
 Year 2 = 123.53

Note that, with this index, the only changes are the prices over the
years. The quantities for each good remain the same throughout the
years.

Advantages and Disadvantages of the Laspeyres Price Index

The advantages of the index include:

 Easy to calculate and commonly used


 Cheap to construct
 Quantities for future years do not need to be calculated – only
base year quantities (weightings) are used
 Presents a meaningful comparison, as changes in the index are
attributable to the changes in price

The main disadvantages of the index are that it is upward-biased and


tends to overstate price increases (compared to other price indices).
Therefore, it tends to overestimate price levels and inflation. This is due
to:

1. New goods: More expensive new goods that cause an upward


bias in prices.
2. Quality changes: Price increases solely due to quality
improvements should not be considered inflation.
3. Substitution: Substituting goods or services that have become
relatively cheaper for those that have become relatively more
expensive.

Key Takeaways

The Laspeyres Price Index is one of the most commonly used price
indices in measuring the change in the prices of a basket of goods and
services relative to a specified base period weighting.

The numerator of the index is simply the total expenditures of all items
at the observation period using base period quantities, while the
denominator is the total expenditures of all items using base period
prices and quantities.

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