VISION INSTITUTE OF ACCOUNTANCY
BUSINESS MATHEMATICS
INDICES
An index number is an attempt to summarize a whole mass of
data into one figure. The single figure shows how one year differs
from another year.
It is a statistical devise used to measure the change in the level
of prices, wages output and other variables at given times,
relative to their level at an earlier time which is taken as the
base for comparison purposes
A simple price index =
Pn
Po
A simple quantity index =
100 (an unweighted price index)
Qn
Qo
100 (an unweighted quantity
index)
Where pn is the price of a commodity in the current year (the
year for which the price index to be calculated)
Where po is the price of the same commodity in the base year (the
year for comparison purposes)
Similarly Qn and Qo are defined in the same way
AGGREGATE PRICE INDEX NUMBERS AND QUANTITY
INDEX NUMBERS
PRICE INDEX
QUANTITY INDEX
LASPEYRES
pnqo 100
qnpo 100
Poqo
qopo
INDEX
PAASCHES
pn qn 100
qn qn 100
Po qn
qo pn
INDEX
Value index =
p q
Pq
n n
100
o o
MODIFIED FORM OF THE LASPEYRES PRICE INDEX
NUMBER
Laspeyres Price index
w
pn
po
100
Where w0 are the proportions of the total expected in the basic
period. This formula is frequently used to calculate retail price
index.
CHANGING THE BASE OF THE INDEX
For comparison purposes if two series have different base years,
it is difficult to compare them directly. In such cases, it is
necessary to change the base year of one of the series (or both)
so that both have the same base.
It is also necessary to keep the index relevant to current
conditions hence the need to change the base from time to time.
Example;
Year
198 198 198 198 198 199 199 199
5
6
7
8
9
0
1
2
Price
100 104 108 109 112 120 125 140
index
Suppose we wish to change the base year to 1989
We recalculate each index by expressing it as a percentage of
1989
1985
1986
1987
1988
Previous
index
100
Recalculated index
100
104
112
104
108
112
108
109
112
109
1989 (new base 112
year)
1990
120
112
112
112
120
112
100 = 89.3
100 = 92.9
100 = 96.4
100 = 97.3
100 = 100
100 = 107.1
1991
1992
125
125
140
112
140
112
100 = 111.6
100 = 125.0
When changing the base year, it is advisable to update the
weights used in the base year.
CHAIN BASED INDEX NUMBERS
A chain based index is one where the index is calculated every
year using the previous year as the base year. This type of index
measures rate of change from year to year.
This method is suitable where weights are changing rapidly and
items are constantly being brought into the index and unwanted
items taken out. It can be a price or quantity index
Previous
index
198
5
198
6
100
198
7
108
198
8
109
198
9
112
199
0
120
199
1
125
104
Recalculated
Fixed
based
chain
based index
index
100
100(1985 base
year
104
100
100
100
100
104
100
100 = 104
104
108
104
108
100
100 = 108
103.8
109
108
100.9
112
109
109
100
100
109
100
100
100
112
100
100 = 112
102.8
120
112
120
100
100 = 120
107.1
125
120
104.2
125
100
100 = 125
199
2
140
140
120
100 = 112
140
100
100 = 140
The Fishers index
The Fishers index acts as a compromise between Laspeyres
index and Paasche index. It is calculated as a geometric mean of
the two indexes.
Retail price index
It is weighted average of price relatives based upon an average
household in the base year. The items consumed are divided into
groups such as food, housing, transport, alcoholic drinks,
footwear, fuel, light, water, household goods, services e.t.c. each
item included in the index is given a weighting and a price
relative to the base is calculated. Modified form of laspeyres
price index formula is used as a weighted arithmetic mean of
price relatives.
I.e. Retail Price index
W 100
W
pn
po
The index is used by the Government as a guide in determining
the minimum wages, pension rates unemployed benefits (in UK
e.t.c). Trade unions use it as a basis for their wages claims.
Deflation
Indexes may be used to deflate time series so that comparisons
between periods may be made in real terms
It is a process of reducing a value measured in current period
prices to its equivalent in the base period prices. The deflated
value is what would have been necessary to purchase the same
amount of goods as the present value can purchase in the
current period
Deflation Factor =
p q
p q
n n
100
0 n
Deflation of a time series
Yea Average
monthly Retail
r
earnings (shs)
index
Real earnings
1
2
5,000
5,500
100
120
5000 = 5000
5,500
100
120
4,583.3
3
6,000
140
6,000
100
140
4,285.7
4
6,500
170
6,500
100
170
3,823.5
5
7,200
200
7,200
100
200
3,600.0
The technique of index number construction
When preparing index numbers it is important to define
a) The exact purpose of the index
b) How the items are to be selected
c) The choice of the weights
d) The choice of the base
e) The type of average to be used
The base year should be as close to the normal trend as possible.
The best methods should be used for collection of data. The
items should be selected in such a way that they are a fair
representation of all the relevant items.
Due consideration should be given to the weighting of all items
selected
The Geometric Index (Industrial Share index)
This index is an index of 30 selected top industrial companies. It
is calculated by taking an unweighted geometric mean of the
price relatives of the selected shares.
Example
The share prices of ordinary shares of four companies on 1 st
January 1990 and 1st January 1991 were as follows.
Share
Price
on Price
on
1.1.1990
Compan Shs 10
yA
Compan Shs 12
yB
Compan Shs 20
yC
Compan Shs 5
yD
1.1.1991
Shs 12
Shs 15
Shs 25
Shs 6
Using an unweighted geometric index, calculate the index of
share prices at 1.1.1991 if 1.1.1990 is the base date, index 100
Solution
1
12 15 25 6 4
10 12 20 5
1.225
27000
12000
1
4
2.25 4
1
percentage increase = 22.5% index = 122.5
Inflation
The inflation rate for a given period can be calculated using the
following formula;
Inflation =
Current retail price index
Retail price index in thebase year
Marshal Hedge Worth Index
Marshal Hedge worth index =
p p
p q
n
100
qn
qn
100
