Module 16: Price Index

Session I
Contents – Session I
• Introduction – purpose and use of Price Index
• What is an Index number
• Aggregate index

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Introduction – Purpose and Use
– What is Price Index?
– Main uses
– Common price indices
 Price Index – an Introduction

Price
• The price of a product – whether goods or services – is simply
defined as the value of one unit of that good or service.
• Prices are observable in monetary transactions.
• Prices are generally determined on a market.
• Wages are also considered as ‘price’ of the factor service
‘labour’.
• The price of each good or service is made up of several cost
factors.

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 Price Index – an Introduction

Price Index

Of all the index numbers, price indices are the most important
and are commonly used in various economic and business
contexts.
Price index compares the prices of a group of commodities at a
certain time or place with prices of the base period or place,
respectively.

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Price Index – an Introduction

What are Price Indices?

• A price index compares the prices of a set of products at
different points in time, or at different locations.
• It therefore measures price changes or price differentials
rather than price levels.
• Price indices capture changes in prices of a set of goods &
services actually paid or received, at different stages of
distribution, such as:
– price paid by the customer (CPI) or
– price received by the producer (output PPI).

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Price Index – an Introduction

Main Purpose
• As the price level goes up, the value of money goes down.
• The main purpose of compiling a price index is to measure
the change in purchasing power of the economy’s currency
with respect to
– the specified group of goods and services purchased or sold
– by a specified type of purchasers or sellers.

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Price Index – an Introduction

Use of Price Indices

Main uses:
• Measurement of inflation – changes in general level of
prices over time.
• Calculation of real values – National Accounts Statistics at
constant prices.
• Calculation of indexed values – adjustment of wages &
salaries.
• Contract escalation.
• Determination of foreign exchange rates and for
International studies.
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 Price Index – an Introduction

Prices change in stage of economic process

Often case:
P
P Final
consum
P ption
Retail
P Wholesale

P
Final
Products
Intermedia
te outputs
Raw
materia
ls
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Price Index – an Introduction

Different Price Indices

There are different kinds of price indexes. For each different

stage of processing price indices are compiled.
These differ with respect to
• items they take into account.
• buyers or sellers involved in the transactions.
• periodicity, i.e. whether the prices are observed weekly or
monthly or yearly.

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Price Index – an Introduction

Common Price Indices

• Principal Price indices
– Consumer Price (CPI)
– Producer Price Indices (PPI): input PPI and output PPI
 Services Producer Price Indices like BSPI & CSPI and CGPI
– Import and Export Price Indices (XMPI)
– Purchasing Power Parity (PPP)
– GDP implicit price index or GDP deflator
• Others
– Labour Cost Index – wage rate index
– Energy Price Statistics
– Construction Cost Index
– House rent index – often part of CPI
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 Price Index – an Introduction

Price Index in this module

• Of the various price indices mentioned in the previous slide,

this module focusses on mainly on CPI.
• The PPI and XMPI are also discussed briefly, especially in the
context of weighting, product classification and interpretation.
We will start with a discussion on Index numbers in general,
before turning to Price indices.

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What is an Index Number
– Simple price index
– Types of simple price index
 Index number

Definition: Index numbers

Definition: Index numbers are statistical devices designed to

measure relative changes in the level of a phenomenon
(variable or a group of variables) with respect to
̶ time, or
̶ geographical location or
̶ other characteristics such as income, profession, etc.
Index numbers measure magnitude of change.
We will discuss index numbers for changes with respect to time.

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 Index number

Index numbers - Examples

The variable may be

- price of a particular commodity or a group of commodities
- volume of trade, imports and exports, agricultural or
industrial production, etc.
- Human and livestock population
- national income of a country or
- cost of living of persons belonging to particular income
group/profession, etc.

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Index number

Types of Indices

Types of indices
• Simple index number
• Simple aggregate index
• Weighted aggregate index.
We begin by considering the simplest form of index numbers,
“simple indices”.
In the context of price index, the simple indices are called
‘price relatives’.

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Simple Index
 Simple Index

Definition: Simple Index

Formally, a simple index number or an elementary index – It – of

a variable Y is defined as
yt
It  ( )  100
y0
where I t : Index in the current period of item
yt : Value of one unit in the period t
y0 : Value of one unit in the base period

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 Simple Index

Index number: Examples

Example 1: The average Year TShs per Index
US$ 2000=100
exchange rate of Tanzanian
shillings (TShs) to US dollars 2000 800.7 100.0
(US$) for each year is
converted into index numbers 2001 876.4 109.5
with the year 2000 as a base 2002 966.6 120.7
year as follows:
2003 1038.6 129.7
Find out the value of the index
2004 1089.3 136.0
for 2005.
2005 1128.8 ?

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 Simple Index

Rule of three

The “rule of three” is a very useful procedure when deriving

index numbers from a series of statistics.
Index The value in the cell D is
Year TShs per US$ (2000=100) worked out as follows:
D = B*C/A =
2000 A → 800.7 B → 100.0
100*1128.8/800.7 = 141.0
2001 876.4 109.5
2002 966.6 120.7
2003 1038.6 129.7
2004 1089.3 136.0
2005 C → 1128.8 D → ?

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 Simple Index

Index number: Examples

Example 2: The population of
Index
Zambia each year may be Year Population
2000=100
converted into index numbers
with the year 2000 as a base 2000 9,885,591 100.0
year as follows:
2001 10,089,492 102.1
2002 10,409,441 105.3
2003 10,744,380 108.7
2004 11,089,691 112.2
2005 11,441,461 115.7
2006 11,798,678 119.4
2007 12,160,516 ?

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 Simple Index

Index number: Examples

Example 3: The average price Year Price of Elementary
tea leaves Index
(in a local currency) of tea per Kg. (2000=100)
leaves (of a particular kind)
for each year is given in the
2010 1500 100.0
following table. These when
converted to index numbers 2011 1550 103.3
with the year 2000 as a 2012 1620 108.0
base year are the
2013 1710 114.0
‘elementary indices’ or
‘price relatives’: 2014 1850 123.3
2015 2000 ?

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 Simple Index

A few questions

Exercise 1
Fill in the missing index numbers in the boxes with a ? mark
answer the following:
• By what percentage has the 2007 population of Zambia has
grown since the year 2000?
• By how much (in percentage) TShs to US$ exchange rate has
increased during 2000 to 2004?
• What is the price relative of tea leaves in 2015 with respect
to 1010?

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Aggregate Index
 Aggregate Index numbers

Why index numbers?

• Indices of the elementary kind, discussed above, have little

value in themselves.
• But they can be used to compile more complex “composite”
indices, involving many different goods and services.
• In economic statistics, the term “index numbers” is usually
reserved for these more complex “composite” indices.

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 Aggregate Index numbers

Need for Composite Index numbers

• When there is only one product, the elementary index
(discussed above) serves well as a measure of change in price
of the product or volume of its production.
• Further, when there is a whole variety of products, with prices
and volume of production / consumption changing at
different rates, one can measure the change in money value
of production / consumption by a single indicator, as shown in
the next slide.

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Aggregate Index numbers

Measuring change in value

where qti represents quantity of ith product in tth period

pti represents price of ith product in tth period
q0i represents quantity of ith product in base
period
p0i represents price of ith product in base period

This is simply the ratio between the total (money) value in the
current period (tth) and that in the base period.
This is called value index in the rest of the presentation.

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 Aggregate Index numbers

Decomposing V0t
C h an
ges i
n price
s

Change in value: V0t

q u a nti ties
n
C hanges i

• But how to separate out the change in value between changes

in price and changes in quantity?
• Constructing composite Index numbers becomes essential for
measuring separately the change in prices or that in volume.
• This leads to what is known as the Index Number Problem

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 Aggregate Index numbers

Index Number Problem (1)

• How to combine the relative changes in the prices and
quantities of various products into a single measure of the
relative change of the overall
– price level and
– quantity level.

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 Aggregate Index numbers

Index Number Problem (2)

• Or, conversely, how a value ratio pertaining to two periods of
time can be decomposed into
– a component that measures the overall change in prices
between the two periods— the price index and
– a component that measures the overall change in
quantities between the two periods— the quantity
(volume) index.
• There is no unique way to achieve this.

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 Composite Index numbers

Types of composite indices

• There are only two types of composite indices, (because “value”
indices are always simple relatives or ratios of value):
– Price indices
– Quantity (or volume) indices
• Quantity and volume are synonyms here. In economic statistics,
changes in quality are considered as changes in quantity and
included with them.
• Usually the index is assigned a value of 100 in some selected
base period.
• The values of the index for other periods indicate the average
percentage change (in prices or quantities) from the base
period.
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 Composite Index numbers

Price and Quantity Index

• A price index reflects the average of the proportionate
changes (%) in the prices of the specified set of goods and
services between two periods of time.
• A quantity index reflects the average of the proportionate
changes (%) in the quantities of the specified set of goods and
services between two periods of time.

For the rest of this module, we will focus on Price Index only.

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End of Session I