3. How to calculate indices

The basic idea of index calculation and the formulae used in index calculation are very simple: all we need to know is today's price, quantity or value and the corresponding observations for the base period. The base period may be the previous month, the previous year or some other point of time. Today's price (for example) is then entered as the numerator (i.e. above the bar) and the base period price as the denominator (i.e. below the bar) and the quotient is multiplied by one hundred - and we have an index!

We begin this lesson by looking at the basic concepts of price, quantity and value. This brings us to one of the basic formulae of index calculation, i.e. price * quantity = value. In addition, you will learn in this lesson about the most commonly used index formula, such as those developed by Laspeyres, Paasche and Fisher. Why so many different formulae, how do they differ from one another - this you will find out in this lesson.

You will also learn which method to use in calculating indices, the fixed base index or the chain index method. It is important to decide at the outset whether the price at the point of measurement is always compared with the base period (fixed base index) or with the previous point of measurement (chain index). The crucial factor is the point at which the index weights are changed.

Goods, services and geographic regions may have a very different meaning to the total index. It is important to know the specific weight of each commodity in the total index. In this lesson you will learn how to add up or weight an index at commodity and regional level.

There are often situations where different indices from different base years are available. This lesson concludes by looking at how old indices are chained by using a new index.