Price Index

September 21, 2009

A price index is a standardized average of prices for a given class of goods and/or services in a given duration of time at a particular geographical location. The standardized average is normally a weighted average. It is an index that is used to track inflation by measuring the price changes. Price index is a form of statistic that is meant to help concerned authorities compare how the set prices in general differ from one geographical location to another and between different periods of time.


A broad price index is said to measure the cost of living in a particular economy or the price level while a narrow price index is said to assist producers of certain commodities with pricing and making of viable business plans. In actuality, price index can be useful in assisting to guide investment.

There are three noteworthy price indices:-
(i) Consumer Price Index (CPI) – this is a measure that estimates the average price of consumer services and goods bought by an average household. CPI measures the price change for a steady market basket of goods and/or services from one particular period to another within the same geographical area.
The price index is determined by measuring the price of a normal group of goods that are intended to characterize the typical market basket of a characteristic urban consumer. The percentage change in Consumer Price Index measure inflation estimation. Still on point, Consumer Price Index can be used as an indicator for indexing of salaries, wages, pensions, contracted or regulated prices in case of an inflation.
(ii) Producer Price Index – this price index measures the average changes in prices that domestic producers have received for their production.


(iii) GDP (Gross Domestic Product) Deflator – this is a measure of the price levels of all new products that have been produced domestically in a particular economy. In other words, GDP deflator stands for the total value of all the final products i.e. goods and services that have been produced in a given economy in a given period of time.

Advantages and disadvantages of CPI

Consumer Price Index is easily measurable and has a practically large market basket of goods and services. However, it changes over time (the consumer goods that were in existence in the 90s aren’t the same as those in existence today) and secondly, CPI tends to overstate inflation as it doesn’t account for advancement in technology.

Quality change and price index
Price index normally captures the price changes and the quantity changes for the goods and services produced at a given time, at a given geographical location. However, it fails to capture the improvements (in most cases decline) in the quality of the services and/or goods. As such, agencies in charge of statistics use matched-model price indices for comparison purposes. Matched-model price indices are whereby a single model of a certain good is priced at a single store at various time intervals. However, this method is challenging as it cannot be used on goods and services that have very high earnings in quality features.

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Written by Uncle Sam · Filed Under Economics 

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