3. ⢠Demand is defined as the quantity of a good or service that
consumers are willing and able to buy at a given price in a given time
period.
⢠The Theory of Demand
⢠Other factors remaining constant (ceteris paribus) there is
an inverse relationship between the price of a good and demand.
⢠As prices fall, we see an expansion of demand
⢠If price rises, there will be a contraction of demand.
THEORY OF DEMAND AND PRICE INDEX
4.
5. ⢠an index that traces the relative changes in the price of an individual
good (or a market basket of goods) over time.
⢠a price index is a normalized average of prices for a given class of
goods or services in a given region, during a given interval of time. It
is a statistic designed to help to compare how these prices, taken as
a whole, differ between time periods or geographical locations.
⢠index that tracks inflation by measuring price changes.
WHAT IS PRICE INDEX?
6.
7. ⢠Allowances are an important component in the pay-package of the
organised sector
⢠The amount of allowances is linked to a price index agreed
mutually between the employer and the employee
⢠It is basically in place to protect the consumer from the adverse
effect of price rise
⢠It is basically a type of welfare provided by the employer to the
employee
⢠Different types of price index can be formulated based on the
consumersâ welfare over time
WHY DO WE NEED IT?
8.
9. ⢠For fixing the price index, we have to make certain assumptions to
simplify the process
⢠The tastes and preferences of the consumer remain unchanged over a
period of time
⢠The preferences of the entire body of individuals can be averaged out
and be represented as one
⢠For simplicity, we assume that there are only two goods available in the
market
ASSUMPTIONS MADE FOR FIXING THE PRICE INDEX
10.
11. ⢠Let us assume that there are only two goods available to be
consumed â X and Y
⢠These goods will be consumed over two time periods, T0 and T1
⢠The following table gives a pattern of consumption of X and Y
consumed at the prevailing prices at the given time periods
Time
Px
X
Py
Y
âPtQt
âPoQt
âP1Qt
To
10
10
20
15
400
400
555
T1
18
17
25
12
606
410
606
⢠It can be seen that the price of both the goods has increased in
time
⢠Consumption of âXâ has increased but that of âYâ has fallen
HOW DOES IT WORK?
12. Time
Px
X
Py
Y
âPtQt
âPoQt
âP1Qt
To
10
10
20
15
400
400
555
T1
18
17
25
12
606
410
606
⢠Had the quantity of Y also increased, it would have obvious that its
utility level has also increased
⢠The total expenditure in period 1 is higher than in period 0 â this
could be due to increased prices
⢠It is necessary that the expenditures relating to price rise be
adjusted in order to arrive at real income or expenditure of
consumers
⢠This is why we need price index to derive the welfare for employees
HOW DOES IT WORK?
13.
14. Time
Px
X
Py
Y
âPtQt
âPoQt
âP1Qt
To
10
10
20
15
400
400
555
T1
18
17
25
12
606
410
606
⢠The cost of the quantities consumed in the base of the period of
terminal period is greater â 606 > 555
⢠606 = âP1Q1
>
555= âP1Q0
⢠This means that the cost of goods consumed by the consumer in
the termination period is higher than the cost of the goods in the
base period
⢠Thus Q0 is available to the customer in period 1 but he still chooses
Q1 in period 1
⢠This is because the customer chooses the combination of goods
which maximises his satisfaction â thus his combination is giving
more utility
CALCULATION OF THE PRICE INDEX
15. ⢠Thus we have this generalisation
⢠âP1Q1
âĽ
âP1Q0 which implies U1 > U0
⢠To derive index numbers we divide both sides by the basal âP0Q0
⢠âP1Q1/âP0Q0
âĽ
âP1Q0/âP0Q0 which implies U1 > U0
⢠âP1Q1/âP0Q0 x 100 = Index of income at current prices
⢠(âP1Q0/âP0Q0 x 100 = Laspeyerâs Price Index)
CALCULATION OF THE PRICE INDEX
16.
17. ⢠The tables and data so far have been shown to depict an
improvement in welfare.
⢠A similar approach can be used for situations where a detoriation
in welfare is estimated
⢠âP1Q1/âP0Q0 x 100 = Index of income at current prices
⢠âP1Q0/âP0Q0 x 100 = Laspeyreâs Price Index
⢠âP1Q1/âP1Q0 x 100 = Paascheâs Price Index
⢠Both the indices should be used together and can be used to
provide a consistency check
LASPEYREâS AND PAASCHEâS PRICE INDICES
18. ⢠Laspeyreâs Price Index is used to compare the companyâs welfare
scheme with the prices index of the past to find out the situation of
the welfare program for their employees
⢠When compared with the Income index, this shows improvements
over time
⢠It cannot determine the fall in welfare
⢠Paascheâs Price Index is used to derive the index of real income by
comparing the companyâs welfare program with current prices
⢠When compared with the Income index, this shows detoriations
over time
⢠It cannot identify improvement in welfare
LASPEYREâS AND PAASCHEâS PRICE INDICES
19. ⢠Welfare improvement with time
⢠Necessary condition : Income Index > Passcheâs Price index
⢠Sufficient condition : Income Index ⼠Passcheâs Price index
⢠Welfare deterioration with time
⢠Necessary condition : Income Index < Passcheâs Price index
⢠Sufficient condition : Income Index ⤠Passcheâs Price index
LASPEYREâS AND PAASCHEâS PRICE INDICES