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Give example to calculate the price level
Imagine that we have created a particular basket of services and goods. We calculate price level at four different points in time during 2008 without changing the content of the basket (the weights are unchanged). Assume that we find following time series for price level:
Point in time
Jan 1, 2008
Feb 1, 2008
March 1, 2008
April 1, 2008
Price level
60 770
62 400
62 850
Reason for choosing 607.70 is that we want index to be equal to 100 for the first point in time. Advantage of having an index which starts with 100 is that we would have a clearer picture of the evolution of prices. We may, for instance, immediately determine that prices rose by 2.68% on average in January and by 3.42% during 3 months January to March.
Note that percentage change of original price level and percentage change of the price index is the same. Percentage change won’t depend on which point in time we select as our “base” (giving price index a value of 100). Using price index, percentage change during January is (62400 – 60770)/60770 = 2, 68% that is exactly the same as percentage change of price index.
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