Laspeyres Index Method - Essay Example

?Micro Economics Part (A) Price indexes are very important metrics to economists, governments and to the general public to define an entire economy’sprice level. Laspeyres index method is a price index formula broadly used to compute indexes. Laspeyres index, which was proposed by a German economist Etienne Laspeyres (1834-1913) measures the current cost or quantities of a product that was purchased in a specified base period. Unfortunately, Laspeyres does not take an account that as prices rise the consumer will automatically buy less of the purchase or will go for a cheaper product, in both the cases reducing the sales volume of the particular product. As an outcome of this oversight, Laspeyres index methodically overstates price rises. “A Laspeyres index number is a form of index number where prices, quantities or other units of measure over time are weighted according to their values in a specified base period” (Laspeyres Index Number 2001). A benefit of using Laspeyres index is that it does not require revised knowledge of the present payment model. Following are the calculations of Laspeyres Price Index for 2009. year Food price index Spending on food Transport price index Spending on transport 2001 94.9 60814 101.6 96954 2009 123.2 81185 99.7 122265 The Laspeyres Price Index for 2009 = ((Q food price (2001)* P food (2009)) + ((Q Transport price (2001)* P transport (2009)) ((Q food price (2001)* P food (2001)) + ((Q Transport price (2001)* P transport (2001)) ((94.9*81185)) + ((101.6*122265)) / ((94.9* 60814)) + ((101.6* 96954)) ((7704456.5 + 12422124)) / ((5771248.6 + 9850526.4)) ((20126580.5 / 15621775)) 1.288367071 Laspeyres Price Index for 2009 = 1.288367071 Then, naturally, the cost is multiplied by 100. Therefore, the base year cost of the index will at all times be equal to 100. Index value 2009 = 1.288367071* 100 = 128.8367071 =128.84. PART B: ‘Quantity proxy’ for food and transport for 2001 and 2009. Quantity proxy for food (Q food) = food spending / food price index Food spending Food price index Quantity proxy for food 2001 60814 94.9 640.8219 2009 81185 123.2 658.9692 Following are the graphical representations of Quantity proxy for food: Quantity proxy for Transport proxy (Q transport) = transport spending / transport price index Transport spending Transport index Quantity proxy for transport 2001 96954 101.6 954.2717 2009 122265 99.7 1226.329 The graphical representation of Quantity proxy for Transport proxy: Quantity proxy’ for a household with the same food & transport budget, but which spent its entire budget on food. Food spending Transport spending Entire budget Food price index Quantity proxy 2001 60814 96954 157768 94.9 1662.466 2009 81185 122265 203450 123.2 1651.38 Quantity proxy for a household, which spent no money on food, but spent its entire (food & transport) budget on transport Food spending Transport spending Entire budget Transport index Quantity proxy 2001 60814 96954 157768 101.6 1552.835 2009 81185 122265 203450 99.7 2040.622 The indifference curve is a graph, which shows the different bundles of goods. In the different bundle of goods the consumer also has indifferent choices. At each point on the indifference curve the consumer has different preference choice, which varies according to the income of the consumer, the change in price of a product and the change in prices of products. A budget line symbolizes the mixture of combinations of two commodities, which can be procured with a given income, taking into account the assumed prices of goods. The quantity proxy for household with the food and transport budget together and spent its entire budget on food is more in the year 2001, compared to the entire budget spent on transport in the year 2001. Similarly the quantity proxy for household with the food and transport budget together and spent its entire budget on transport is greater in the year 2009 as compared to the entire budget spent on food in the year 2001. “The index numbers of prices may be calculated for a certain locality, for a certain class of people like textile workers or office clerks etc. The index numbers may be required for geographical regions like districts or provinces etc. First of all we decide the purpose of making the index numbers. Once the purpose is decided, then we decide about the scope and the area or the people who are to be considered” (Construct Price Index Numbers 2008). An indifference curve shows the consumer’s preference for the mixture combination of two goods. The budget line is a continuous line and the line shifts when a person’s income changes. When there is a fall in the income of a person with the price of commodity remaining unchanged, the budget line shifts towards the left. Whereas, when there is a change in the price of one commodity keeping the income and the price of the other commodity the same, then the consumer usually purchases that good more than the past and the budget line takes a rotational approach. With the budget line and the indifference curve, the choice of the customer can be understood. When income remains constant and the price of commodity increases and the demand for the commodity, whose price has increased remain constant, then the demand for that product falls. PART C: The Substitution Effect is the effect owing barely to the relative price change, controlling for the transform in actual income. So to compute it one should ask, what is the bundle that would make the customer just as happy as before the value change, rather if they had to create their choices faced with the latest prices. Following are the graphical representation of the income effect and substitution effect of (A) and (B) of assessed coursework. x BC Y Indifference curve examining begins with the value function. The utility function is care for as an index of utility. All that is essential is that the utility index transform as extra preferred bundles are consumed. Unresponsiveness curves are typically numbered with the number increasing as more chosen bundles are inspired. On the other hand, it is not essential that numbers be utilized. The benefit of numbers is that their utilization makes the math simpler. Numbers familiar with index indifference curves include no basic significance. Reference List Construct Price Index Numbers. 2008. Emathzone. [Online] Available at [Accessed 28 Nov. 2011]. Laspeyres Index Number. 2001. Glossary of Statistical Terms. [Online] Available at [Accessed 28 Nov. 2011]. Read More