FRAME 16.

Note that in every case we compared the price for each year to the base year price and

multiplied by 100. Index numbers are used to compare prices for like items over time. The

purpose of any ratio is to compare values. It is much easier to relate the index each year to a

common base year index (100) than to compute the percentage change in price between each of

the seven years. For instance, it is easier to look at the 117 for 1989 and compare it to the 100

for 1985 than to compare the price 8 in 1989 to 0 in 1985. The index immediately tells us

that the price in 1989 is 17% greater than in the base year. It is important that the base year

selected be a "typical" year.

How are index numbers actually used? The most common area of application is price

indices. Two examples of price indices are the Simple Price Index (SPI) and the Consumer Price

Index (CPI). The Simple Price Index includes just one item or commodity. If you combine Simple

Price Indices, then you have an aggregate price index. An example of an aggregate index is the

CPI. The CPI is a statistical measure of change in prices of goods and services bought by urban

wage earners and clerical workers. There are some 400 food, housing, and transportation items

in this index and they are grouped by type of commodity. These are then weighted to form the

overall index. Let us look at an income index. Your income has probably increased in dollars

over the past 5 years. What about its real purchasing power? Has it increased or decreased?

To find out, we must convert your income for each of the 5 years into constant dollars so they

can be compared. Thus,

YEAR

INCOME

CPI

1985

,000

100

1986

10,500

108

1987

11,500

120

1988

12,000

125

1989

13,500

150

To find the purchasing power of your 1989 income in 1985 dollars, use the following ratio:

Base Year Value = Current Year Value

Base Year Index Current Year Index

But since the base year index is always 100, we can rewrite the ratio as follows:

Base Year Value = Current Year Value X 100

Current Year Index

Substituting values from the table, we have the following:

Base Year Value = 13,500 X 100 = 90 X 100 = 9,000

150

1989 income is ,000 vice 1985 income. You lost
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,000 in purchasing power.

QUESTION: What is your 1988 income in 1985 dollars? ____________

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