What is a price index?

A price index is a measure of relative price changes so that you can equally compare the values of different periods of time or places. Most indexes use a weighted average to compare the cost of the markets over time or location. For example, a price index can help you determine the cost of bread in the year 1912 vs 2021. 

Consumer Price Index

The consumer price index measures the cost of living based on changes in retail prices. These indexes are based on the data from the sample of a population to determine the “market basket” of goods and services. Prices are combined with the relative importance of the goods to create a compare index price of the goods or services. 

Laspeyres index

The Laspeyres index was created by German economist Étienne Laspeyres (1834–1913). It is a consumer price index principle used to measure current prices or quantities in relation to a selected time period. The Laspeyres price index is calculated by taking the ratio of the total cost of purchasing a specified group of commodities at current prices to the cost of that same group at base-period prices and multiplying by 100. 

Other price indexes

Over centuries economists developed different methods for calculating indexes that determine the normalized value of goods and services and purchasing power. Other common price indexes include:

• Paasche index
• Lowe indices
• Fisher index and Marshall–Edgeworth index

Price index formula

Consumer Price Index Formula (CPI):

To calculate consumer price index or CPI for short use this formula:

CPI=Cost of Market Basket in Base Year/ Cost of Market Basket in Given Year×100

CPI will give you an accurate comparison of two market baskets in any given year. For example, the average cost of a home in 2005 vs 2021. 

How to Calculate Price Index

Calculating the price index is easy using these 3 steps. For example, let’s say you want to calculate the price index of a product or service between three different years. 

Step 1: Determine base value

Determine the different values you want to compare. In this case, we are looking at goods with different prices over three different years.

Now for the number of items: 

Step 2: Plug your values into the formula

Now plug your values into the Laspeyres price index formula. 

Price index Year 0 =  (10×110) + (15×220) + (18×280) / (10×110) + (15×220) + (18×280) 

Price index Year 1 = (15×120) + (10×220) + (20×300) / (10×110) + (15×220) + (18×280) 

Price index Year 2 = (12×130) + (15×240) + (24×350) / (10×110) + (15×220) + (18×280)

Step 3: Complete the formula

Now with a few quick calculations, we can determine the price index for each year. The price index for each year are as follows:

• Year 0: 100
• Year 1: 105.93
• Year 2: 143.64

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