What is Paasche Price Index?
Paasche Price Index is a price index that is used to measure the price level and cost of living in an economy and to calculate inflation. It was invented by a German Economist, Hermann Paasche. The Paasche Price Index Value is used to understand the actual inflation in the basket of goods compared to the base year. The index generally uses a base year of 100 for analysis. An index greater than 100 indicates the inflation impact and an index less than 100 indicates deflation. Year 0 will be termed as the base year while calculating year, will be termed as an observation year. The Paasche Price Index is used primarily by economists to analyse the economic growth of the country taking into consideration the inflation in the goods and services. Paasche price index is also useful in calculating the Fisher-Price Index.
Formula
The formula for calculating the Paasche Price Index is as follows:
Where:
- Pi,t is the price of the individual item at the observation period
- Pi, 0 is the price of the individual item at the base period
- Qi,t is the quantity of the individual item at the observation period
- Qi, 0 is the quantity of the individual item at the base period.
Although the mathematical formula for the calculation seems confusing, it is simply the total expenditure of all items at the observation period using current observation period quantities and prices, while the denominator is the total expenditure for all items at the base period using current observation period quantities as base period prices. The formula can be rewritten as:
Pros and Cons of Paasche Price Index
Pros:
- Focuses more on the consumption patterns in the economy by taking the current level of quantities into consideration.
- Considers the entire basket of goods and services.
- Gives a reflection of the governmental policies on daily goods and services since the same is being consumed by the general public every day.
- Give the trigger warning or signal to the government about rising prices and increase the cost of living. This may hamper growth for certain classes of people.
Cons:
- Does not take into account the changing taste and the preference of the general public.
- It ignores the growing economy.
- Data from the current quantities available are difficult to extract
- Overall, this is a costly process to execute.
Conclusion
The Paasche Price Index is one of the crucial ratios in order to determine the intensity of inflation. The Paasche Price index is calculated on a monthly basis. It is used to understand the trend, whether it is going in the upward or the downward direction. This index is widely used in the economical work and finance ministry. This enables the user to keep a track of the inflation trends so that future plans and policies can be drafted accordingly.