BAMS2923 STATISTICAL ANALYSIS FOR BUSINESS

CHAPTER 4: INDEX NUMBER

➢ An index number is used to measure changes in a variable

or a group of related variables with respect to time.

➢ Variables (or economic commodities) may be prices,

quantities, values, wages, expenditures etc.

➢ The index for the base year is always 100. The notation for
indicating a base year is 20XX = 100.

➢ In general, an index number is the comparison of a value at

two different time points and is expressed as a percentage.

Value in year under study

Index Number =  100
Value in base year

➢ If the resulting index is > 100, then there is an increase in

value in the year under study compared to the base year.
Example: An index of 131 indicates that there has been a
31% (131 – 100 = 31) increase since the base year.

➢ If the resulting index is < 100, then there is a decrease in

value in the year under study compared to the base year.
Example: An index of 92 means there has been a decline
of 8% (92 – 100 = – 8) since the base year.

Some Notations
Period Price, p Quantity, q Value, v
Base p0 q0 v0 = p0 q0
Current pn qn vn = pn qn

Index Relatives
➢ Measures the change in a single distinct commodity
pn qn
Price relative = p  100 Quantity relative =  100
0
q 0

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Example 1: Index relatives
From the following data, calculate the price and quantity relatives
for Year 2 (Year 1=100) for both items.
Year 1 Year 2
Item Price Quantity Price Quantity
X 438 37 462 18
Y 322 26 384 45

Solution:
Year 1 Year 2
Item p0 q0 pn qn Price relative Quantity relative
X 438 37 462 18

Y 322 26 384 45

Example 2: Indexing data

Year 1 2 3 4 5
Sales (RM million) 12 15 18 19 16
(a) Express the sales figures above as index numbers with
(i) base at year 1
(ii) base at year 4
(b) Interpret both the index numbers for year 5.
(c) Find the percentage increase from year 2 to year 3.

Solution:
(a) Year Sales (i) Index of sales (ii)Index of sales
(RM million) (Year 1 = 100) (Year 4 = 100)
1 12
2 15
3 18
4 19
5 16

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(b) The sales index for year 5 has increased by 33.33%
compared to year 1 whereas declined by 15.79% compared to
year 4.

(c) The percentage increase from year 2 to year 3 =

Note:
➢ It is essential to realise that the percentage changes always
relative to the base year. It is not possible to derive the
percentage increase from one year to the next by
subtracting the index number.

➢ In the Example 2(a)(i), the sales index rises by 25 points

(150 – 125 = 25) from year 2 to year 3, which is clearly not
the same as 25%.

➢ However the increase of 25 points from year 1 to year 2 is a

25% increase since year 1 is the base year.

Choice of Base Period

➢ The base period chosen should be a fairly typical period. For
example. If the prices are being indexed then a base year
should be chosen in which prices were neither abnormally
high nor low.

➢ It should be sufficiently recent for meaningful comparisons

drawn.

Change of Base Period

➢ If the base date of a series of indices given is too far in the
past to be relevant today, we may want to change the base
period to a more recent one.

➢ If given two series of index numbers with different base

periods, we will want to change the base period of one index
series to be the same as the other index series to enable
comparisons drawn.
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 Example 3: Changing base
Compare the figures given below by changing the base of one of
the set and comment on the results.
Year 11 12 13 14 15
No. of TV sets sold (Year 12 = 100) 87 100 130 172 200
No. of TV licences issued (Year 1 = 100) 210 230 280 350 400

Solution:
Year No. of TV sets sold No. of TV licences issued
(Year 12 = 100) (Year 12 = 100)
11 87
12 100
13 130
14 172
15 200

Comment: From year 12 and up to year 15, sales of TV sets

increased more rapidly than the number of TV licences issued.

Combining Series of Index Numbers

➢ In statistical digests and similar publications, we often

encounter series of index numbers in which a change of
base occurs in the middle.

➢ The process of combining two series of index numbers into

a single continuous series is called splicing two indices
together.

Example 4: Splicing two index series

A country’s retail price index (RPI) is given as follows.
Year RPI Year RPI
(Year 1 = 100) (Year 5 = 100)
3 138.4 6 118.1
4 160.0 7 133.3
5 193.0 8 145.9
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Splice the two series to give a continuous index series with base
at (a) Year 1 (b) Year 5

Solution:
(a) Retail Price Index (b) Retail Price Index
Year
(Year 1 =100) (Year 5 =100)
3 138.4 **
4 160.0 **
5 193.0 100
6 * 118.1
7 * 133.3
8 * 145.9

*RPI (Year 1=100) ** RPI (Year 5=100)

193.0 100
= RPI (Year 5=100) × = RPI (Year 1=100) ×
100 193.0

Time series of relatives:

There are two ways in which relatives can be calculated.

(1) Fixed base relatives

➢ each relative is calculated based on the same fixed time

point.

➢ show the rate of change compared to same base year.

(2) Chain base relatives

➢ each relative is calculated with respect to the immediately

preceding time point.

➢ show the rate of change from year to year.

This year' s figure

➢ Chain index =  100
Previous year' s figure

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Example 5: Chain index
Given below are prices for a food item for the years 1 to 4.
Calculate a set of fixed base relatives (use year 1 as base year)
and chain base relatives.

Year 1 2 3 4
Price RM 2.00 RM 2.20 RM 2.34 RM 2.50

Solution:
Year Price Fixed base relatives Chain base relatives
(RM) (Year 1=100)
1 2.00 100 _
2 2.20
3 2.34
4 2.50

Example 6: Conversion of fixed base to chain based

Convert the fixed base index to a chain based index and interpret
the results obtained.

Year 1 2 3 4
Income index (Year 1 = 100) 100 106 110 117

Solution:
Income index
Year Chain income index
(Year 1 = 100)
1 100 _
2 106
3 110
4 117

Comment:
Over the period year 1 to year 4, there were annual percentage
increases of 6%, 3.77%, and 6.36% respectively.

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Example 7: Conversion of chain based to fixed base
Convert the chain income index numbers obtained in Example 6
to a fixed base index numbers with Year 1 = 100.

Solution:
Year Chain income index * Income index (Year 1 = 100)
1 -

2 106

3 103.77

4 106.36

For Year 2 onwards,

Previous year' s index
* Income Index = This year' s chain index 
100

COMPOSITE INDEX NUMBER

➢ It is an index number which is obtained by combining the

information from a set of economic commodities of like kind.

➢ For example, an index of housing costs might consider

components such as mortgage payments or rent, interest
rate, repairs, insurance and so on.

➢ The method of constructing composite index number can be

grouped into:

(1) Unweighted index number (2) Weighted index number

Unweighted Index Number

A. Simple Aggregate Method

 pn
 Simple aggregate price index =  100
 p0
 qn
 Simple aggregate quantity index =  100
 q0
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Limitations:
➢ It is not used frequently because the index can be influenced
by the units of measurement.

➢ no consideration is given to the relative importance of the

commodities

B. Simple Average of Relatives Method

1  pn 
 Simple average of price relative index =   100 
n  p0 
q 
 Simple average of quantity relative index = 1   n 100 
n  q0 

where pn  price of current year qn  quantity of current year

p0  price of base year q0  quantity of base year
n  total number of items included in the construction of
these indices.

Notes:
➢ We could obtain the same value for the index regardless of
units of measurement.
➢ The index fails to consider the relative importance of the
items included in the index.

Example 8:
The following table reports the prices for 3 dairy products for year
1 and year 2.

Dairy products Year 1 Price (RM) Year 2 Price (RM)

Milk (per litre) 9 13
Butter (per kg) 26 29
Cheese (per kg) 34 38

(a) With year 1 as the base year, calculate

(i) the simple aggregate price index for year 2,
(ii) the simple average of price relative index for year 2,
(b) If the price of milk was quoted in 5-litre unit, recalculate the 2
indices in part (a) above.
(c) Comment on the findings of part (a) & (b).
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Solution:
(a)
Dairy products Year 1 Year 2 pn
 100
p0 pn p0
Milk (per litre) 9 13
Butter (per kg) 26 29
Cheese (per kg) 34 38

(i) Simple aggregate price index for year 2

 pn
=  p  100 =
0

(ii) Simple average of price relative index for year 2

1  pn 
= n  p 100  =
 0 

(b)
Dairy products Year 1 Year 2 pn
 100
p0 pn p0
Milk (per 5-litre) 9  5 = 45 13  5 = 65
Butter (per kg) 26 29
Cheese (per kg) 34 38

(i) Simple aggregate price index for year 2

 pn
=  p  100 =
0

(ii) Simple average of price relative index for year 2

1  pn 
= n p  100  =
 0 

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(c) The simple aggregate price index in part (a) is 116. This
means that the aggregate group of prices had increased by
16% in the one-year period. The simple aggregate price
index in part (b) is 126, different from 116, this also means
that the aggregate group of prices had increased by 26% in
one-year period. The two simple aggregate prices indices
differ significantly showing that the particular units used in
price quotations affect or influence the value of the index.
To overcome this difference, price relatives are considered.

The simple average of price relative index for both parts is

123. This indicates that the mean of the group of indexes
increased by 23% from year 1 to year 2. The positive
feature of the simple average of price relative index is that
we would obtain the same value for the index regardless of
the units of measurement. The negative feature of this
index is that it fails to consider the relative importance of the
items included in the index. For example, milk and butter
receive the same weight, even though a typical family might
spend far more over the year on milk than on butter.

Weighted Index Number

➢ The term weight used is assigned to individual item to

indicate the relative importance of each item in the
distribution list

➢ Price, quantity, volume or percentage is the common

example of weight

➢ The item has highest weighted value is most likely to be the

most important item

A. Weighted Aggregate Method

➢ This method involves multiplying each component value by

its corresponding weight and adding these products to form
an aggregate for both time points.
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 w p n
 Weighted aggregate price index =  100
wp 0
wq n
 Weighted aggregate quantity index =  100
wq 0

B. Weighted Average of Relatives Method

➢ This method involves calculating index number for each of

the given components, then using the given weights to
obtain a weight average of the indices.

 Weighted average of price relatives index =

1  pn 
w
 p
w  100 
 0 

 Weighted average of quantity relatives index =

1 q 
w
 w n  100 
 q0 
where w  weight

Example 9:
The data of the following table give details of the mix, prices and
standard quantities used in making up a large bag of mortar.

Components of Price in Year 1 Price in Year 2 Standard

mix (RM) (RM) quantity
A 1.50 3.00 8
B 3.40 4.25 3
C 10.40 8.84 1
Find the weighted price index for year 2 (Year 1 = 100) by using
(a) average of relatives method
(b) aggregate method
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Solution:
Components Year 1 Year 2 p 
w n 100 
of mix po pn w wpo wpn  p0 
A 1.50 3.00 8
B 3.40 4.25 3
C 10.40 8.84 1

Total

Weighted average of price relatives index for year 2 (Year 1 = 100)

1  pn 
=
w
 p
w   100  =
 0 

Weighted aggregate price index for year 2 (Year 1 = 100)

w p n
=  100 =
wp 0

The component of mix A has such a high weighting (w = 8, which

is more than half of the total weight), its index = 200 had a major
impact in increasing the value of the composite index. In other
words, the size of the index will be strongly influenced by the
weight given to component A and strongly reflects A’s price rise.

Comparison of the Two Weighted Indices:

The aggregate index: The average of relatives index:
➢ uses the magnitudes of the ➢ uses the value of the
actual values of the relatives for each component
component commodities commodity
➢ is affected by actual ➢ is affected by relative
increases or decreases increases or decreases
➢ truly representative of the ➢ not truly representative of the
data data
➢ being affected by extreme ➢ can be used for smoothing
values out extreme values
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Special weighted aggregate index:
Laspeyre Indices (or based weighted indices)
➢ use base time period weights.

Laspeyre Price Index Laspeyre Quantity Index

q 0 p n p 0 q n
=  100 =  100
q 0 p 0 p 0 q 0
use base time period quantities use base time period prices
( q 0 ) as weights ( p 0 ) as weights

Paasche Indices (or current weighted indices)

➢ use current time period weights.

Paasche Price Index Paasche Quantity Index

q n p n p n q n
=  100 =  100
q n p 0 p n q 0
use current time period use current time period
quantities ( qn ) as weights prices ( pn ) as weights

Example 10:
Compute the Laspeyre and Paasche Price Indices for the
following data and interpret the results obtained.
Year 1 Year 2
Commodity Price Quantity Price Quantity
A 2 8 4 6
B 5 10 6 5
C 4 14 5 10
D 2 19 2 13
Solution:
Year 1 Year 2
Commodity p0 q0 pn qn q0 p n q0 p0 qn pn qn p0
A 2 8 4 6
B 5 10 6 5
C 4 14 5 10
D 2 19 2 13

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 q 0 p n
Laspeyre Price Index =  100 =
q 0 p 0
Compared with the base year prices for year 1, prices for year 2
have

q n p n
Paasche Price Index =  100 =
q n p 0
Compared with the base year prices for year 1, price for year 2
have

Value Index Number

p n q n
➢ Value Index =  100
p 0 q 0
where p 0 q 0 = total values of all commodities in the base period
p n q n = total values of all commodities in the period under
study

Example 11:
Price and quantity data have been collected for three items.
Calculate, using year 1 as base year,

i) Laspeyre Quantity Index for year 2.

ii) Paasche Quantity Index for year 2.
iii) Value Index for year 2.

Year 1 Year 2
Item Price (RM) Quantity Price (RM) Quantity
P 20 60 30 55
Q 25 30 28 40
R 30 40 34 45

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Solution:
Year 1 Year 2
Item p0 q0 pn qn p0 q0 p0 qn pn q0 pn q n
P 20 60 30 55
Q 25 30 28 40
R 30 40 34 45
3150 3450 4000 4300
(i) p0 qn
Laspeyre Quantity Index =  100 =
p0 q0
(ii) pn qn
Paasche Quantity Index =  100 =
pn q0
(iii) p n q n
Value Index = p q  100 =
0 0

Differences between Laspeyre’s Index and Paasche’s Index

Laspeyre’s index Paasche’s index
➢ Use base time period ➢ Use current time period
weights weights
➢ Denominator is calculated ➢ The denominator is changing
once and is used from period to period
throughout the series
➢ Involves less time and cost ➢ Involves more time and cost
➢ Comparisons can be made ➢ Comparisons can only be
for base period and other made between current and
periods base period
➢ *Use in stable economic ➢ Use in dynamic economic

* The taking of base period quantities/ prices as weights in

Laspeyre index implies that the quantities/ prices we used do not
vary over time. This may not be appropriate in practice as
technological progress, new methods, changes in tastes, outputs,
etc will cause the base period weights to become irrelevant in a
dynamic economy. Paasche index tends to remedy the criticisms
directed to Laspeyre index because the weights used will be
revised each period.
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Consumer Price Index (CPI) or Retail Price Index or Cost of
living index
➢ It is a Laspeyre index. It is the most widely reported index
which measures the changes in prices from one period to
another for a fixed market basket of goods and services.
➢ An economic indicator of the rate of inflation.
➢ Used to determine real income, to find the purchasing power
of the dollar, to adjust wages, pension & so on.

Deflating a time series (Deflation)

 Time series that are measured in dollars will change because

of price change as well as quantity change

 Deflation  a process to remove the effect of these changes

from a time series

 Deflated value is sometimes called real value

 To deflate a series, divide each year’s entry by the deflator

Actual value
Real value =  100
Deflator

 The deflator is the appropriate price index for that year

Annual income
 For e.g. Real annual income =  100
Consumer Price Index

Sales
Real / deflated sales =  100
Producer Price Index

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Example 12:
The following table gives the money wages and cost of living
index numbers based on Year 1. Calculate the real wages.

Year 1 2 3 4 5
Wages (RM) 65 70 75 90 100
Cost of living index number 100 105 110 120 125

Solution:
Year Wages (RM) Cost of living Deflated money wage
index number or real wage
1 65 100

2 70 105

3 75 110

4 90 120

5 100 125

Example 13:
The following table shows the values of average annual income
of a company and the CPI from Year 1 to Year 5.

Year 1 2 3 4 5
Average annual income ($’000) 600 630 655 680 700
CPI (Year 1 = 100) 100 101 106 107 109
Find (a) the index of average annual income using Year 1 = 100,
(b) the real average annual income,
(c) the index of the real average annual income using Year 1
= 100.
Interpret your finding.

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 Solution:
(a) Index of (b) (c)
Average average CPI
annual *Real average **Index of
Yr annual (Yr1=
income income annual income real income
($’000) 100)
(Yr1=100) ($’000) (Yr 1=100)
1 600 100

2 630 101

3 655 106

4 680 107

5 700 109

Average annual income

* Real average annual income =  100
CPI
** Index of real income
Real average annual income of the year
=  100
Year 1 real average annual income
Interpretation:
The real average annual income (r.a.a.i.) of each year (Year 2 –
5) is more than the r.a.a.i. of base Year 1. For e.g. the r.a.a.i. in
Year 5 is $642,202 which is 7.03% more than the r.a.a.i. in Year
1. But the increase in the average annual income =
700 − 600
 100% = 16.7% for year 5 compared to year 1.
600
Income has been adjusted for inflation using CPI to get real
income. Index of income shows increasing value from Year 1 to
5. Index of real income shows increasing value from Year 1 to 5
except Year 3. Note the rate of increase in income is higher than
that of real income for each year.
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Example 14: Deflating sales
The following shows the annual sales of Eugene Enterprises, a
small manufacturer and the Producer Price Index (PPI reflect the
price charged by the manufacturer for the items purchased). Find
the deflated sales and comment on your findings.

Year Sales ($000) PPI (Year 1 = 100)

1 1,482 100.0
2 1,491 119.2
3 1,502 126.1

Solution:
Year Sales ($000) PPI *Deflated sales
(Year 1 = 100) ($000)
1 1,482 100.0

2 1,491 119.2

3 1,502 126.1

Sales
*Deflated sales = PPI( Yr.1 = 100)  100

Comment:
The real annual sales have declined from year 1 to year 2 by
$231,161 and from year 1 to year 3 by $290,882.

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Purchasing Power of the Dollar
$1
➢ Purchasing power of dollar =  100
CPI
➢ Suppose the CPI this month is 200 (Year 1 = 100). What is
the purchasing power of the dollar?
$1
➢ Purchasing power of a dollar =  100 = $0.50
200

➢ A dollar in this month is worth only $0.50 in year 1.

Example 15:
The following table shows the Consumer Price Index (CPI) for 4
particular years. Find the purchasing power of the dollar for each
year and comment on your results.
Year 1 2 3 4
CPI (Yr.1 = 100) 100.0 103.5 108.0 113.6

Solution:
Year CPI (Yr.1 = 100) *Purchasing power of the dollar
1 100.0

2 103.5

3 108.0

4 113.6

Comment: The purchasing power of the dollar has declined as

$1 in year 2, 3 and 4 is worth only $0.97, $0.93 and $0.88 in year
1 respectively.

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BAMS2923 STATISTICAL ANALYSIS FOR BUSINESS
TUTORIAL 4 (INDEX NUMBERS)
Q1. The following table shows the sales of a product over five
years.

Year 1 2 3 4 5
Sales (RM000) 20 26 40 44 52

(a) Express the sales figures above as index numbers with

year 1 as base year.
(b) Rebase your answers using year 3 as base year.
(c) By how much percentage has the sales changed in year
5 compare to year 4?

2. Given below are the prices for a food item for 5 years.
Calculate a set of fixed based relatives (use year 1 as base
year) and chain base relatives.
Year 1 2 3 4 5
Price (RM) 4.00 4.40 4.68 5.00 5.80

3. Fruit prices and the amounts consumed for year 1 and 2 are
given in the table below.

Year 1 Year 2
Fruit
Price Quantity Price Quantity
Bananas (pound) 0.25 100 0.38 120
Grapefruit (each) 0.29 50 0.27 55
Apples (pound) 0.35 85 0.35 85
Strawberries (basket) 1.02 8 1.40 10
Oranges (bag) 0.89 6 0.99 8
Using year 1 as the base, determine:
(a) the simple aggregate price index and simple aggregate
quantity index for year 2.
(b) the simple average of price relative index and the
simple average of quantity relative index for year 2.

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 (c) the Laspeyre price index and the Laspeyre quantity
index for year 2.
(d) the Paasche price index and the Paasche quantity
index for year 2.
(e) the value index for year 2

4. You are assisting with the work on a Maintenance

Department’s budget for the next quarter of the year 2019.
The Maintenance Department’s budget for the current
quarter (just ending) is RM200,000. The quantity used and
average price for 4 materials are shown below:
Material Quantity Average price
(units) used in payable per unit
current Current Next
quarter quarter quarter
A 9 20 21
B 13 24 25
C 8 18 18
D 20 50 52
(a) Calculate the Laspeyre price index for the next quarter,
using the current quarter as base.
(b) By using your answer obtained in part (a), estimate the
budget for the next quarter. Assuming that the
quantities to be used:
(i) remain the same,
(ii) each increase by 10%.

5. The Trade Union Association of Orlando, Florida, maintains

indices on the hourly wages for a number of the trades.
Unfortunately, the indices do not have the same base
periods. Listed below is the information on plumbers and
electricians. Shift the base periods to 2015 and compare the
hourly increases.
Year Plumbers' wage index Electricians' wage index
(2010 = 100) (2012 = 100)
2015 133.8 126.0
2018 159.4 158.7
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6. Sam Steward is a freelance computer programmer. Listed
below are his yearly wages for the years 2014 through 2018.
Also included is an industry index for computer programmers
that reports the rate of wage inflation in the industry.

Year Wage ($000) Index (2000 = 100)

2014 125.0 148.3
2015 134.8 160.6
2016 145.2 173.6
2017 156.6 187.9
2018 168.8 203.3
Shift the base period to 2014 and compute Sam's real
income for the period. Did his wages keep up with inflation,
or did he lose ground?

7. The following table gives information on the Consumer Price

Index and the monthly take-home pay of Bill Martin, an
employee at the Jeep Corporation.
Year Monthly take- CPI (2000 = 100)
home pay
2016 $25,000 170.8
2018 $41,200 183.3
(a) What was Bill Martin’s real income in year 2016 and
2018? Interpret your findings.
(b) Calculate the purchasing power of $1 in year 2018 and
interpret your result.

Tutorial 4 (Answers)
1. (a) 100, 130, 200, 220, 260 (b)50, 65, 100, 110, 130 (c) 18.18
2. Fixed based relatives: 100, 110, 117, 125, 145
Chain base relatives : - , 110, 106.36, 106.84, 116
3. (a) 121.07 , 111.65 (b) 118.72, 117.67 (c) 118.90, 112.41
(d) 120.53, 113.95 (e) 135.49
4. (a) 103.79 (b) (i) RM207,580, (ii) RM228,338
5. Plumbers: 119.13 Electricians: 125.95
6. Index (2004=100): 100, 108.29, 117.06, 126.70, 137.09
Real income ($'000): 125, 124.48, 124.04, 123.60, 123.13
7. (a) $14,637 $22,477 (b) $0. 55
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