FRAME 16.
USES OF INDICES
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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