Use of Index Numbers
Economics: IB Diploma, topic 2.3.7
Index Numbers
Index numbers are used by economists to both represent and to understand economic data in a much clearer way. Economists typically report price levels in each period as an index number, rather than a dollar amount.
Index numbers
- Economists create price indices to calculate an overall average change in relative prices over time.
- E.g. if you were told the average price of housing in the US was $256,010, and it is forecast to rise to $268,221, it is hard to process this data. But if you were told the index level was forecast to rise from 107 to 110, you would have a better idea of the significance of this change.
How to calculate an index number
- You need to choose a "base". This is commonly a year but doesn't have to be.
- It is the “thing” that everything else is being compared to.
- E.g. if the base year is 2008, then the index number in 2009 is being compared to 2008, the chosen base year.
- It is convention to set the base year index number equal to 100.
- To calculate an inflation rate we use the following formula: (New value / Base year value ) x 100.
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Example of calculating an index number
- In this example, 2015 has been chosen as the base year, with an index value of 100.0.
- To calculate the index value in 2016, the calculation is ($257,111 / $250,010) x 100 = 102.8.
- This represents a 2.8% rate of inflation between 2015 and 2016. This is calculated by finding the percentage change in the index number over that period.
Test yourself on Use of Index Numbers
If the price level increases from an index of 140 to 154, what does this indicate?
If the base year data (where the index = 100) for a firm's revenue is $200 000, what is the index number for revenue equalling $600 000?
What is the index number which represents a doubling in value compared to the base year?