Laspeyres Index

What is the Laspeyres Price Index?

Laspeyres Index is a methodology to calculate the consumer price indexConsumer Price IndexThe Consumer Price Index (CPI) is a measure of the average price of a basket of regularly used consumer commodities compared to a base year. The CPI for the base year is 100, and this is the benchmark  point.read more by measuring the change in the price of the basket of goods to the base year. It was invented by Etienne Laspeyres, an economist from Germany to analyze the changes in the prices as compared to the base year period.

  • The index generally uses a base year of 100 to analyze the index. An index greater than 100 implies the rise in prices and an index less than 100 implies a fall in prices.
  • Year 0 will be termed as the base year while calculating year will be termed as an observation year period.
  • It is more used by economists to analyze the economic growth of the country taking into consideration the inflation in the goods and services.

Laspeyres Price Index Formula

Laspeyres Index Formula= ∑ ( Observation Price * Base Qty) / ∑ ( Base Price * Base Qty)
Laspeyres-Index

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Laspeyres Index (wallstreetmojo.com)

Where,

  • Observation Price refers to the price at the current levels for which the index needs to be calculated.
  • Observation Qty refers to the qty at the current levels for which the index needs to be calculated.
  • Base Price refers to the price at year 0 which is known as the base year for calculating the index.

Example of Laspeyres Price Index

Let’s take an example for a better understanding of this index.

You can download this Laspeyres Index Excel Template here – Laspeyres Index Excel Template

Let us take the below-mentioned example to understand the calculation of the Laspeyres price index for a commodity A, B & C.

Laspeyres Index Example

Solution :

In the above Example, To calculate the Laspeyres price index, the quantities for the future years are not required hence the same is not been plotted in the table. Below mentioned are the steps to calculate the Laspeyres price index.

Laspeyres Price Index at Year 0 = 100. Since both the numerator and denominator here will be the same, the base year result would be 100 and which shall be used in future years to compare the performance of the goods and services and drafting a suitable plan of action to control the same if there is any excessive price rise or decline which would affect the consumers directly and in turn the economy.

This index will show a relative and absolute valuation without taking into account the future changes in the economy and the government policies which keep on changing every year to benefit the common public at large.

Calculation of Laspeyres Price Index at Year 1 will be –

Laspeyres Index Example.1

Laspeyres Price Index Formula for Year 1 = {(25*10)+(30*20)+(35*30)} / {(10*10)+(15*20)+(20*30)}

Index at Year 1 = 190

Calculation of Laspeyres Price Index at Year 2 will be –

 Example.1.1

Laspeyres Price Index Formula for Year 2 = {(40*10)+(45*20)+(50*30)} / {(10*10)+(15*20)+(20*30)}

Index at Year 2 = 280

Hence we can observes the inflation impact in the prices since the prices have increased from 100 to 190in year 1 and finally uptp 280 in year 2 i.e 2,8 times from year , the price of commodities have climbed up.

Advantages of Laspeyres Index

Is one of the most important tools to observe the inflation in the basket of goods and services by comparing the current price levels with the base year quantities.

Below mentioned are some of the major advantages of Laspeyres index ratio:

  • It is very easy to calculate in an excel sheet.
  • It focuses on base year quantities and current level prices only hence there is no need to calculate the quantities for the future years.
  • It gives a fair picture and value of the commodities since base year quantities are been used thus ignoring the current level quantities.
  • It is a good parameter to frame future policies that will control inflation.

Disadvantages of Laspeyres Index

  • It does not take into account the current level of quantities.
  • Ignores the growing economy.
  • Since there can be a change in the production level in the future years, ignoring this fact will not be correct in the model.
  • It completely ignores the new entrants in the market.
  • It does not take into account the change in quality and substitute goods that can have a major impact on the prices.
  • In the case of Substitute goods, with the old ones becoming obsolete may push the price up to and also the levels of production. hence by ignoring the future quantities will not show a correct figure of the index and will have an in a direct impact on the government policies ahead.

Limitations of Laspeyres Index

  • More mathematical less practical.
  • It is not used commonly among economists since the Pastiche index gives a better picture.
  • Prices tend to rise on a yearly basis keeping in mind the consumption patterns and rising standard of living among the people.
  • Deciding the base year is a major challenge.

Points to Note

A significant change in the Laspeyres price index will give a trigger point to the government to control the growing inflation by implementing new policies that will clear the market thereby reducing the price rise pressure on the common public.

Conclusion

It is one of the key ratios in order to determine the speed of inflation for goods and services. Since this index is different from the Paasche price indexPaasche Price IndexPaasche price index refers to a methodology for determining the actual inflation by measuring a commodity's price change compared to the base year. It was discovered by Hermann Paasche, who was a German Economist.read more which uses current level quantities in its formula, while the Laspeyres price index uses base year quantities, both cannot be compared with each other and will give an altogether different picture reflecting the rise or fall in the prices.

This index is been widely used by the economist in taking the financial and economic decision for the country and to drive the consumer market without passing on the pressure of price rise to the common public.

Recommended Articles

This has been a guide to what is the Laspeyres Index and its definition. Here we discuss the formula to calculate the Laspeyres Price index along with an example and advantages and disadvantages. You can learn more about accounting from following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *