Laspeyres index, Microeconomics

Assignment Help:

Laspeyres index

The Laspeyres index tells us that:

- The amount of money at present year prices which an individual requires to purchase bundle of goods and services which was selected in base year divided by cost of purchasing same bundle at the base year prices.

* Computing Raheela's Laspeyres cost of living index 

- Setting quantities of goods in the year 1997 equal to what were bought by her sister, but setting the prices at their 1997 levels result in expenditure of 

$1,720 (100 x 2.20 + 15 x $100)

*  The cost of living of her adjustment would be $1,220.

* The Laspeyres index is:  $1,720/$500 = 344.

*  This overstates true cost of living increase.

559_Laspeyres index.png

What Do You Think?

- Does the Laspeyres index overstate the true cost of living index always? ? Yes!

- The Laspeyres index supposes that consumers do not alter their consumption patterns as the prices change.

- By increasing purchases of those items which have become comparatively cheaper, and decreasing purchases of relatively more expensive items consumers can achieve same level of utility without having to consume the same amount of goods.

*  The Paasche Index

- Computes the amount of money at current year prices which an individual requires to purchase a current amount of goods and services divided by cost of purchasing same bundle in base year.

*  Comparing Two Indexes

- Assume:

- Two goods: Food (F) and Clothing (C)

*  Comparing the Two Indexes 

- Suppose:

• PFt & PCt be current year prices

  • PFb & PCb be base year prices
  • Ft & Ct be current year quantities
  • Fb & Cb be base year quantities

- Both the indexes involve ratios which involve today's present year prices, PFt and PCt.

- Although, the Laspeyres index depends on the consumption of base year, Fb and Cb.

- While, Paasche index relies on today's present consumption, Ft and Ct .

* Then the comparison of Laspeyres and Paasche indexes gives following equations:

2072_Laspeyres index1.png

- Sarah (1990)

  • Cost of base year bundle at the current prices equals

             $1,720 (100 lbs x $2.20/lb + 15 books x $100/book)

  • Cost of same bundle at the base year prices is

             $500 (100 lbs x $2.00/lb + 15 books x $20/book)

- Sarah (1990)

2293_Laspeyres index2.png

• Cost of buying current year bundle at the present year prices is

             $1,260 (300 lbs x $2.20/lb + 6 books x $100/book)

• Cost of same bundle at the base year prices is 

             $720 (300 lbs x $2/lb + 6 books x $20/book)

2290_Laspeyres index3.png
The Paasche index will understate cost of living as it assumes that individual will buy the present year amount in the base year.


Related Discussions:- Laspeyres index

Concept of elasticity of demand, Question (a) Describe clearly the thre...

Question (a) Describe clearly the three concepts of elasticity of demand. Use appropriate examples and diagrams to support your answer. (b) Consider you have been appointed

Manpower requirements approach, Normal 0 false false false ...

Normal 0 false false false EN-IN X-NONE X-NONE MicrosoftInternetExplorer4

Strength of the multiplier in microeconomics, Q. Strength of the multiplier...

Q. Strength of the multiplier in microeconomics? Multiplier: An initial stimulus to spending (in form of new consumer, business or government purchases) generally results in a

Select demand schedule and a supply schedule for apples, •Create a demand s...

•Create a demand schedule and a supply schedule for your product.. •Using these schedules, draw a demand curve and a supply curve using PowerPoint or Excel. Use these to determine

Monopoly help, Monopoly and Oligopoly help?!? 1. Your firm sells a perfume....

Monopoly and Oligopoly help?!? 1. Your firm sells a perfume. The daily demand for your perfume estimated by your economists is given by P=150-5Q Your marginal cost is constant at $

Identify the four essential economic activities, Identify the four essentia...

Identify the four essential economic activities. The four main economic activities are: a)  resource maintenance, b)  production, c)  distribution, and d) consumpti

102, why does the quantity of salt tend to be unresponsive to changes in it...

why does the quantity of salt tend to be unresponsive to changes in its price

122, 0.767 g of phosphorus and 0.650 g of chlorine were allowed to react. A...

0.767 g of phosphorus and 0.650 g of chlorine were allowed to react. After the reaction was complete, all of the chlorine had been consumed, but 0.650 g of phosphorus remained. How

Analysing the digital economy relative to e business, Problem: a) What ...

Problem: a) What factors would you consider when analysing the digital economy relative to e business? b) "The growing use of the internet by consumers and businesses has re

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd