Which is better - $ 100 right now or in a year? Of course, any sane person will choose the first option. After all, tomorrow is always associated with uncertainty, and folk wisdom familiar from childhood teaches that a bird in the hand is better. But what if in a year we are expected not $ 100, but $ 150? In order to understand this issue, you need the Laspeyres index and other indicators similar in functionality.
Real and nominal values
All economic indicators can be divided into three groups:
- Stream Values.
- Assets (stocks).
- Indicators of economic conditions.
Stream values reflect the transfer of values in the process of economic activity from one entity to another, while the reserves - their accumulation and use. Therefore, the former are measured by quantity over a period of time, and the latter at a certain point. However, it must be understood that a change in flows is always associated with a decrease or increase in stocks. The former include, for example, investments and savings, and the latter include government debt. The interest rate, rate of return, and inflation are indicators of the economic situation.
Matching process
The Paasche and Laspeyres indices are used to compare the indicators of different years, expressed in monetary terms. In this case, they talk about real and nominal values. A good example is gross domestic product. Nominal GDP reflects the value of all final goods produced in the country for the year at current prices. At first glance, it seems that an increase in this indicator always indicates the growth of the state economy. However, in fact, to understand the ongoing processes, one cannot do without calculating the nominal GDP. And for this we need price indices. Usually they are distinguished by three: Laspeyres, Paasche and Fischer. All of them are dimensionless quantities, the main function of which is to display how many times and in which direction the nominal indicator differs from the real one.
Consumer price index
If this indicator is less than unity, then real GDP is greater than nominal. This adjustment is called inflation. A similar situation is possible against the background of a fall in the general price level. However, it is found quite rarely in the modern market economy of most countries of the world. If the Laspeyres index is less than unity, then nominal GDP is deflated. As a result, the latter decreases. Thus, the real gross product is equal to the nominal divided by the Laspeyres index. To calculate the latter, a “consumer basket” is used, which consists of many goods used by economic entities. Moreover, its composition is not constant, but varies depending on the methodology of an international organization or a national statistical office.
Calculation of the Laspeyres index
The formula of this indicator includes only two quantities. Both are associated with the “consumer basket”. Therefore, the accuracy of the indicator is closely linked precisely with the methodology of choosing the most appropriate set of goods. The Laspeyres index itself is calculated extremely simply. It is the result of dividing the current value of the basket by it, but in the base year. The latter is also extremely important to choose the right one.
GDP deflator
Thus, the Laspeyres index is calculated on the basis of a fixed set of goods based on the base year. It does not take into account changes in the structure of manufactured goods. The Laspeyres index does not at all reflect the substitution effect associated with a decline in wealth due to higher prices. Therefore, it often overestimates the real level of price increases. However, all these shortcomings are taken into account by the Paasche index. It is calculated based on a changing consumer basket. That is, the current set of goods is used, not the basic one.
This means that the structure of production is taken into account. In addition, it takes into account not only the group of consumer goods. Real GDP is equal to the nominal divided by the deflator. Therefore, if the Paasche index is less than unity, then, as in the previous case, inflation is performed. More is deflation. However, this indicator also has disadvantages. For example, it often underestimates the increase in the price level due to the fact that it does not take into account the decline in the well-being of the population against the background of a rise in price.
Fisher Index
The third indicator is considered the most adequately reflecting the real dynamics of the price level. It averages the two previous indices, eliminating their flaws. This indicator is equal to the square root of their product.
