Question

In Year 1 people bought 10,000 units of Food at a price of $8 and 2000 units of Clothing at a price of $20. In Year 2 people bought 11,000 units of food at a price of $9 and 2100 units of clothing at a price of $25. Using Year 1 as the base year, calculate the price level for year 2 and the inflation rate (the percentage increase, Hint: The base year value is 100) using:

a) The Fixed Weight approach

b) The Variable Weight approach

Answer 1

a) The Fixed Weight approach: Inflation = Value of a fixed basket at current prices divided by the value of the same basket at base year prices - 1

= (10000 * 9 + 2000 * 25) / (10000 * 8 + 2000 * 20) - 1 = 16.67%

Price Level in Base Year = 100

Price Level in Year 2 = 16.67% * 100 + 100 = 116.67

Here we considered the base year production as the fixed Basket of goods.

b) Variable Weight Approach: Inflation = Value of current output at current prices divided by the value of current output at base year prices - 1

= (11000 * 9 + 2100 * 25) / (11000 * 8 + 2100 * 20) - 1 = 16.54%

Price Level in Base Year = 100

Price Level in Year 2 = 16.54% * 100 + 100 = 116.54

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