Question

Explain how price indexes are used and give an example.

Answer 1

Changes in price level are measured by means of a scale called the price index. This is the most useful instrument for measuring price level change. Price indexes are used to measure inflation in most countries, each focusing on the prices of a collection of goods and services that are important to an economy segment.

A price index is a price change indicator, using a percentage scale. A price index, called a market basket, may be focused on the prices of a single item or a specified set of items. For example, in calculating the con-sumer price index, several hundred goods and services such as rent, energy, and automobiles are utilized. Because a market basket includes a variety of goods and services, it provides a more comprehensive inflation pressure measure than a single item would.

We know that money is valued for the goods and services. Their prices reflect the relative value thereof. When prices go up the amount that can be purchased with a fixed amount of money goes down; when prices fall, the amount that can be purchased increases. In other words, the value of money rises when prices fall; and the value of money falls when prices rise.

Rice index number created giving equal weights to all commodities is called simple price index number, all commodities are given equal importance in this case. The calculation of the average price simply divides the sum of prices by the number of commodities.