What is an index number and why is one used in preference to raw values?

An index number expresses a value as a proportion of its value in a chosen base period, which is set equal to 100. It is used because it converts quantities measured in different units, such as the price of bread in pence and the price of a car in pounds, into comparable figures that can be averaged together. It also makes the size of a change immediately readable, since an index of 118 says at once that the value is 18 per cent above the base.

A basket of goods cost £250 in the base year and £265 one year later. Calculate the price index for the second year and the rate of inflation.

The index is the current cost divided by the base year cost, multiplied by 100: 265 divided by 250 is 1.06, and multiplied by 100 gives an index of 106.0. The inflation rate is the percentage change in the cost: 265 minus 250 is 15, divided by 250 is 0.06, which is 6.0 per cent. When the base year index is 100, the index value minus 100 gives the percentage change directly, which is why 106.0 corresponds to 6 per cent.

A price index rises from 108.0 to 112.3. Calculate the rate of inflation over the period.

The change in the index is 112.3 minus 108.0, which is 4.3. Divide by the starting value: 4.3 divided by 108.0 is 0.039815. Multiplied by 100 this gives 3.98 per cent, or approximately 4.0 per cent. Note that the answer is not 4.3 per cent: the difference between two index numbers is only a percentage change when the starting value is exactly 100.

Why is it wrong to say that an index rising from 120 to 126 represents 6 per cent inflation?

The rise of 6 index points must be expressed as a proportion of the starting value, not of 100. Six divided by 120 is 0.05, so the inflation rate is 5.0 per cent, not 6 per cent. Reading the point difference as a percentage is only valid when the starting value is 100, which is true in the base year and almost never afterwards.

An index has a base of 2015 equal to 100. Its value in 2020 is 118 and in 2024 is 141.6. Rebase the series so that 2020 equals 100 and give the 2024 value.

Divide each value in the series by the value in the new base year and multiply by 100. For 2024 that is 141.6 divided by 118, multiplied by 100. This equals 1.2 multiplied by 100, which is 120.0. The rebased figure of 120.0 tells you directly that prices in 2024 were 20 per cent above their 2020 level, which the original series concealed behind two numbers neither of which was 100.

Why does rebasing an index change all its numbers without changing any of the information it contains?

An index number is only a ratio to a chosen reference point, so shifting that reference point rescales every figure by the same constant factor. The proportional relationships between periods, and therefore every percentage change that can be calculated from the series, are unaffected. Rebasing is done for readability, so that recent periods sit near 100 and comparisons with the present are easy to read off.

CCEA A-Level Economics 4410

Key Economic Concepts

Topic overview The four factors of production Positive statements and normative judgements Economic agents and what they are trying to achieve Capital goods and consumption goods Product markets and factor markets

The Basic Economic Problem of Scarcity and Choice

Topic overview Scarcity, choice and opportunity cost Drawing and reading the production possibility frontier Using a PPF to show choice, opportunity cost, efficiency and growth Why an economy operates inside its frontier Specialisation and the division of labour Free market, planned and mixed economies

Demand and Supply in Product Markets

Topic overview What determines demand and what determines supply Movements along a curve versus shifts of a curve Why the demand curve slopes downwards Why the supply curve slopes upwards: marginal cost and the profit incentive Consumer surplus and producer surplus When consumers do not behave rationally

Markets and Equilibrium

Topic overview Market equilibrium and how markets clear How shifts in demand and supply change the equilibrium Price signals, incentives, rationing and the role of profit Joint, composite and derived demand and joint supply Tracing effects between interrelated markets Community surplus and allocative efficiency Demand and supply in housing, energy and commodity markets Indirect taxes and subsidies: impact and incidence

Elasticity of Demand and Supply

Topic overview Price elasticity of demand: measuring and interpreting Income and cross elasticity: normal, inferior, substitutes and complements Price elasticity of supply What determines the value of an elasticity Elasticity and total revenue How useful is elasticity for firms and government?

Factor Markets: Labour

Topic overview How a competitive labour market sets the wage Elasticity of labour demand and labour supply Wage differentials and why they persist Economic rent and transfer earnings Flexibility: trade unions, welfare and migration Minimum wages and government intervention in the labour market

Market Failures and Imperfections

Topic overview Market equilibrium, the social optimum and the meaning of market failure Externalities: private, external and social costs and benefits Community surplus and the externality diagrams Calculating and interpreting welfare loss Public goods, quasi-public goods and the free rider problem The consequences of missing markets for public goods Merit goods and demerit goods Information gaps and asymmetric information The consequences of merit goods, demerit goods and information failure Market power and other market imperfections Income and wealth inequality Absolute and relative poverty

Government Intervention in Markets

Topic overview Why governments step into markets Indirect taxes Subsidies, and choosing between taxes and subsidies Maximum and minimum prices State provision Regulation Information provision Tradeable pollution permits Government failure

The Circular Flow of Income

Topic overview Households, firms and the two-way flow Injections and withdrawals in an open economy with government Equilibrium and change in the circular flow

Measuring National Income

Topic overview Three routes to the same total: income, expenditure and output GDP as a measure of welfare and its limitations Domestic or national? GDP and GNP compared Nominal and real values: correcting for price changes Total and per capita measures

Aggregate Demand

Topic overview The four components of aggregate demand Why the aggregate demand curve slopes downwards Movements along and shifts in aggregate demand Factors that shift aggregate demand Investment: gross, net and fixed capital

Aggregate Supply

Topic overview Why short-run aggregate supply slopes upwards Factors that shift short-run aggregate supply Movements along and shifts in aggregate supply From the short run to the long run What determines long-run aggregate supply Keynesian and neoclassical views of long-run aggregate supply

Macroeconomic Equilibrium

Topic overview How aggregate demand and aggregate supply determine equilibrium Applying AD-AS analysis to growth and unemployment Applying AD-AS analysis to inflation

Macroeconomic Objectives

Topic overview Why governments target inflation, unemployment, the external balance and growth Objectives beyond the main four: the environment and the distribution of income and wealth Picturing inequality: the Lorenz curve and the Gini coefficient Where the objectives collide: the main policy conflicts Judging the trade-offs: how sharp is a conflict?

Inflation

Topic overview Inflation, deflation and disinflation: what the words actually mean Measuring the rate: the CPI and the RPI Working with index numbers Building a price index: the basket and the significance of weights Demand-pull and cost-push inflation The costs and consequences of inflation and deflation The policy response to inflation

Unemployment

Topic overview The claimant count and the ILO measure of unemployment Calculating and interpreting unemployment statistics Unemployment and economic inactivity: a distinction that changes the numbers The types of unemployment and what distinguishes them The causes of unemployment and of economic inactivity The costs and consequences of unemployment and inactivity Policies for unemployment and intervention in the labour market

Economic Growth

Topic overview Actual and potential growth on a production possibility frontier Measuring economic growth The economic cycle and output gaps The causes of economic growth Benefits, costs and the sustainability of growth Policies to promote economic growth using AD–AS analysis

Fiscal Policy and Its Effects

Topic overview What fiscal policy is and how it works Government spending and taxation: the main categories Direct and indirect taxation Fiscal policy in the AD-AS model Evaluating the impact of fiscal policy on output, employment, prices and agents

Monetary Policy

Topic overview The nature of monetary policy and the interest rate instrument The transmission mechanism from interest rates to aggregate demand Monetary policy in the AD-AS model Evaluating the impact of monetary policy on output, employment, prices and agents

Supply-Side Policies

Topic overview The nature of supply-side policy and tax cuts Deregulation and evaluating market-based supply-side policy Competition and innovation as supply-side policy Infrastructure as supply-side policy Labour market reform Education, training and the skills of the workforce Labour productivity: determinants and significance Supply-side policies in the AD-AS model Evaluating the impact of supply-side policies

Exchange Rates and the National Economy

Topic overview What an exchange rate is and how it is measured Exchange rate changes in the AD-AS model Holding the exchange rate above or below the market clearing level Why a government might have an exchange rate policy Evaluating the impact of exchange rate changes on output, employment, prices and agents

Short Run Versus Long Run

Topic overview The short run, the long run and the law of diminishing returns Fixed, variable and total costs of production Calculating and drawing the short-run cost curves Revenue curves: total, average and marginal revenue The profit-maximising output Shutdown, breakeven, and normal and supernormal profit Long-run cost, economies of scale and minimum efficient scale Efficiency, X inefficiency and the effects of firm size

Business Objectives

Topic overview Why firms pursue maximum profit Alternative objectives: revenue, growth, managerial utility, satisficing and the environment Ownership, control and the principal-agent problem Stakeholders, and public versus private sector objectives

Business Growth

Topic overview How and why firms grow, and why some stay small Organic growth versus merger and acquisition Horizontal, vertical and conglomerate integration Evaluating the motives for and consequences of growth

Measuring Markets

Topic overview Market size, market share and market growth The n firm concentration ratio Difficulties in measuring market share accurately Sales value against sales volume

Analysing Market Structures

Topic overview What defines a market structure Price and output across the structures Efficiency across the market structures Market structure and innovation How useful are the models of market structure?

Perfect Competition

Topic overview The price taker's revenue curves and short-run equilibrium The firm and the industry side by side How the market moves from the short run to the long run

Monopoly

Topic overview Barriers to entry Monopoly equilibrium and its consequences Price discrimination Natural monopoly Creative destruction

Monopolistic Competition

Topic overview The firm's demand curve when products are differentiated Short-run equilibrium for the firm Long-run equilibrium and excess capacity How the market moves from the short run to the long run

Oligopoly

Topic overview Concentration and interdependence: what marks out an oligopoly Collusion and price leadership Price wars and sustaining collusion Non-price competition and product differentiation The kinked demand curve model Game theory and the pay-off matrix Evaluating the costs and benefits of oligopoly

Contestable Markets

Topic overview What makes a market contestable Sunk costs and hit-and-run entry How ease of entry changes the behaviour of firms Judging contestability and its significance

Competition Policy

Topic overview The aims and shape of competition policy Breaking up firms and controlling mergers Regulation, regulators and price caps Evaluating regulation and its alternatives Taxation and subsidies as competition remedies Nationalisation Privatisation, and choosing between public and private ownership Banning unfair trading practices Judging competition policy and government failure

Trade and Globalisation

Topic overview Calculating absolute and comparative advantage Evaluating comparative advantage and its limits The gains and losses from free trade Globalisation and its effects Foreign direct investment The instruments of protectionism Evaluating protectionism The World Trade Organisation Trading blocs, trade creation and trade diversion

Economic Development

Topic overview What economic development means and how it differs from growth The difficulties of measuring development National income statistics and comparisons of living standards The Human Development Index Growth in less developed countries: benefits, costs and constraints Promoting development: aid, institutions, debt and trade

Balance of Payments

Topic overview How the balance of payments is put together Consequences of current account deficits and surpluses Policies to correct current account imbalances Expenditure-switching and expenditure-reducing policies

Exchange Rate Systems and Competitiveness

Topic overview How foreign exchange markets operate The influences on currency demand and supply Monetary policy, intervention and other influences on the exchange rate Fixed and floating exchange rate systems The Marshall-Lerner condition and the J-curve The effect of exchange rate changes on the current account Trade-weighted exchange rate indices Purchasing power parity and comparing competitiveness Evaluating exchange rate policy

European Union (EU)

Topic overview The economic case for membership of a trading bloc The costs and constraints of membership, and the position of candidate countries Enlargement, withdrawal and changes in the structure of the union The Eurozone: one currency and one interest rate

Monetary Policy and the Financial Sector

Topic overview Central banks, the banking sector and the money supply Setting the base rate and the transmission of monetary policy The Fisher equation of exchange and the quantity theory of money The financial sector and the real economy Moral hazard in banking Regulating the financial system Regulation and the money supply in a global economy Quantitative easing The money supply and monetary policy in an open economy The effectiveness of monetary policy

Fiscal Deficits and the National Debt

Topic overview The deficit and the debt: a flow and a stock What determines the size of a fiscal deficit Discretionary policy and automatic stabilisers Financing the deficit: bonds, borrowing and crowding out The benefits and costs of a deficit and of the national debt Fiscal policy, macroeconomic objectives and economic agents

Macroeconomic Policies and Objectives in a Global Economy

Topic overview Comparing the performance of different economies Global events and how they reach the domestic economy Responding to external demand and supply shocks Problems and constraints facing policymakers How the priority given to macroeconomic objectives has changed Comparing policies against one another

Quantitative Skills in Economics

Topic overview Ratios, shares and proportions in economic data Percentages and percentage changes in economic data Averages, medians and quantiles Index numbers, weighting and rebasing Converting money values to real values Cost, revenue and profit Elasticity: calculating the number and reading its meaning Choosing and reading economic charts and diagrams Interpreting economic data critically

Inflation

Working with index numbers

2 things to know
Unit AS 2

Overview

Turning a price into an index, reading a weighted index, and comparing series that are measured in different units.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Key term

Why can an index number series never be used to compare price levels between two countries?

Key term

Analyse why the choice of base year affects how a series of index numbers is interpreted, even though it does not change the underlying data.

Questions from this subtopic

Each one with the model answer underneath.

1
What is an index number and why is one used in preference to raw values?
Model answer
An index number expresses a value as a proportion of its value in a chosen base period, which is set equal to 100. It is used because it converts quantities measured in different units, such as the price of bread in pence and the price of a car in pounds, into comparable figures that can be averaged together. It also makes the size of a change immediately readable, since an index of 118 says at once that the value is 18 per cent above the base.
2
A basket of goods cost £250 in the base year and £265 one year later. Calculate the price index for the second year and the rate of inflation.
Model answer
The index is the current cost divided by the base year cost, multiplied by 100: 265 divided by 250 is 1.06, and multiplied by 100 gives an index of 106.0. The inflation rate is the percentage change in the cost: 265 minus 250 is 15, divided by 250 is 0.06, which is 6.0 per cent. When the base year index is 100, the index value minus 100 gives the percentage change directly, which is why 106.0 corresponds to 6 per cent.
3
A price index rises from 108.0 to 112.3. Calculate the rate of inflation over the period.
Model answer
The change in the index is 112.3 minus 108.0, which is 4.3. Divide by the starting value: 4.3 divided by 108.0 is 0.039815. Multiplied by 100 this gives 3.98 per cent, or approximately 4.0 per cent. Note that the answer is not 4.3 per cent: the difference between two index numbers is only a percentage change when the starting value is exactly 100.
4
Why is it wrong to say that an index rising from 120 to 126 represents 6 per cent inflation?
Model answer
The rise of 6 index points must be expressed as a proportion of the starting value, not of 100. Six divided by 120 is 0.05, so the inflation rate is 5.0 per cent, not 6 per cent. Reading the point difference as a percentage is only valid when the starting value is 100, which is true in the base year and almost never afterwards.
5
An index has a base of 2015 equal to 100. Its value in 2020 is 118 and in 2024 is 141.6. Rebase the series so that 2020 equals 100 and give the 2024 value.
Model answer
Divide each value in the series by the value in the new base year and multiply by 100. For 2024 that is 141.6 divided by 118, multiplied by 100. This equals 1.2 multiplied by 100, which is 120.0. The rebased figure of 120.0 tells you directly that prices in 2024 were 20 per cent above their 2020 level, which the original series concealed behind two numbers neither of which was 100.
6
Why does rebasing an index change all its numbers without changing any of the information it contains?
Model answer
An index number is only a ratio to a chosen reference point, so shifting that reference point rescales every figure by the same constant factor. The proportional relationships between periods, and therefore every percentage change that can be calculated from the series, are unaffected. Rebasing is done for readability, so that recent periods sit near 100 and comparisons with the present are easy to read off.

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Key Economic Concepts

The Basic Economic Problem of Scarcity and Choice

Demand and Supply in Product Markets

Markets and Equilibrium

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