Index Number Problems

The theory of index numbers is a course you might take as a second year graduate student. As Freshmen, we will stick to the basics.

Concept

1. Base year: Arbitrary year 2 and 7

2. Index: In base year = 100 therefore percent

3. Real-Nominal Corrector: In base year = 1. therefore fraction

4. Basket of goods: Defines deflator or index

1. Given the following data for a representative market basket:

Concept: Value of market basket(YR)= VMB(YR) = Â_i P_{i (YR)} B_i

Therefore VMB(75) = 10 x 1.0 + 10 x1.0 + 10 x 1.0 = 30

What is VMB(80)?

What is VMB(85)?

Now we are ready to define a simple price index:

ZPI(YR, BYR) = [VMB(YR)/ VMB(BYR) ] x 100

What is the ZPI(80,75)?

ZPI(85,80)?

ZPI(75,80)?

ZPI(80,80)?

2. Real is nominal corrected by a price deflator:

Real [Macro Variable] x Deflator[Macro Variable]/100 = Nominal [Macro Variable]

Deflator in some cases might be called an price index: The two are equivalent

Given the following data:

Year	1980	1985
Nominal GNP	1500
Real GNP	1000	1500
GNP Deflator		200

What is the nominal GNP in 1985? What is the GNP deflator in 1980?

Questions:

We are going to have you write answers on quizzes as prep for the exam. What do we want. NO BULLSHIT!!!!!! We want every word to count and a consise answer.

1. In text they have a more complicated way of computing the GDP deflator using weighted averages. [There are many formulae. We shall only consider 2] In the text they discuss the new BLS weighted average procedure. Why is this a better procedure?

2. Does the CPI over or under measure inflation?

3. Why is the market basket for the GDP deflator different from the market basket for the CPI?

4. Why is the CPI a very important political variable?