Nominal and real indicators: Laspeyres index, its alternatives

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:43

Which is better - $100 now or in a year? Of course, any sane person would choose the first option. After all, tomorrow is always associated with uncertainty, and folk wisdom familiar from childhood teaches that a bird in the hand is better. But what if in a year we are waiting for not 100, but 150 dollars? In order to understand this issue, we need the Laspeyres index and other indicators similar in functionality.

Real and nominal values

All economic indicators can be conditionally divided into three groups:

• Flow quantities.
• Assets (stocks).
• Indicators of the economic situation.

Flow values reflect the transfer of values in the process of economic activity from one entity to another, while stocks reflect their accumulation and use. Therefore, the former are measured by quantity over a period of time, and the latter at a certain moment. However, it must be understood that the changein flows is always associated with a decrease or increase in stocks. The former include, for example, investments and savings, while the latter include public debt. Interest rate, rate of return, inflation rate are indicators of the economic situation.

Matching process

The Paasche and Laspeyres indices are used to compare the performance of different years, expressed in monetary terms. In this case, we talk about real and nominal values. A good example is the gross domestic product. Nominal GDP reflects the value of all final goods produced in the country for the year at current prices. At first glance, it seems that an increase in this indicator always indicates the growth of the state's economy. However, in reality, to understand the ongoing processes, one cannot do without calculating the nominal GDP. And that's what price indexes are for. Usually there are three of them: Laspeyres, Paasche and Fischer. All of them are dimensionless quantities, the main function of which is to display how many times and in what direction the nominal indicator differs from the real one.

CPI

If this indicator is less than one, then real GDP is greater than nominal. This adjustment of the value is called inflation. Such a situation is possible against the backdrop of a fall in the general price level. However, it is quite rare in the modern market economy of most countries of the world. If the Laspeyres index is less than one, thendeflation of nominal GDP. As a result, the latter decreases. Thus, the real gross product is equal to the nominal, divided by the Laspeyres index. To calculate the latter, a “consumer basket” is used, which consists of a variety of goods used by economic entities. Moreover, its composition is not a constant, but differs depending on the methodology of an international organization or a national statistical office.

Calculation of the Laspeyres index

The formula for this indicator includes only two values. Both are linked to the "consumer basket". Therefore, the accuracy of the indicator is closely related to the methodology for choosing the most adequate set of goods. The Laspeyres index itself is calculated very simply. It is the result of dividing the current value of the basket by the same value in the base year. The latter is also extremely important to choose correctly.

GDP deflator

Thus, the Laspeyres index is calculated on the basis of a set of goods fixed in the base year. It does not take into account changes in the structure of manufactured goods. The Laspeyres index does not at all reflect the substitution effect associated with a decrease in well-being due to a rise in price. Therefore, it often overestimates the real level of price growth. However, all these shortcomings are taken into account by the Paasche index. It is calculated on the basis of a changing consumer basket. That is, the current set of goods is used, and not the base one.

This means that the structure of production is taken into account. In addition, it takes into account not only the group of consumergoods. Real GDP is equal to nominal GDP divided by the deflator. Therefore, if the Paasche index is less than one, then, as in the previous case, inflation is performed. More - deflation. However, this indicator also has drawbacks. For example, it often underestimates the increase in the price level due to the fact that it does not take into account the decline in the well-being of the population against the backdrop of a rise in prices.

Fischer Index

The third indicator is considered to be the most adequate reflection of the real dynamics of the price level. It averages the two previous indexes, eliminating their shortcomings. This indicator is equal to the square root of their product.

Use in practice

In the USSR, the Paasche index was preferred. However, after its collapse, this practice was abandoned in the Russian Federation. This was due to the need to process too large amounts of information, and hence high costs. The Laspeyres price index has been used in domestic practice since 1991. He is also given preference in foreign statistics.