Paasche Price Index (Advantages and Disadvantages)

The paasche price index is a consumer price index that compares the price and quantity of a basket of products and services to a base year price and an observation year quantity. It was created by Hermann Paasche, a market analyst (economist) from Germany to comprehend the Actual Inflation in the Basket of Goods contrasted with the base year esteem. The “current weighted index” is how most people refer to it. In most cases, the index is calculated using a base year of 100.

Inflation is represented by an index more than 100, while deflation is represented by an index less than 100. The index is a price index that is used to assess inflation and monitor the general price level and cost of living in the economy. It is usually utilized by financial analysts to examine the monetary development of the nation thinking about the Inflation in labor and products. The index is commonly confused with the Laspeyres Price Index.

The Paasche Index and the Laspeyres Price Index are distinguished by the fact that the former employs current-period quantity weightings while the latter employs base-period quantity weightings. Prices tend to rise on an annual basis as people’s consumption patterns change and their level of living rises.

Formula for the Paasche Price Index –

Paasche Price Index Formula = Sum (Observation Price × Observation Qty) / (Base Price × Observation qty)

  • The price at current levels for which the index must be calculated is referred to as the Observation Price.
  • The Observation Price is the price at current levels for which the index must be calculated.
  • The price at Year 0 (also known as the Base Year for calculating the index) is referred to as the Base Price.

Albeit the numerical condition at the Paasche Price Index appears to be confounding, the numerator is essentially the complete use for all things at the perception time frame utilizing current perception period amounts and costs while the denominator is the absolute consumption for all things at the base time frame utilizing current perception period amounts and base period costs. It overlooks economic growth since commodities and services are included in GDP, and lowering their prices to a certain level can affect the country’s GDP.

Advantages and Disadvantages of the Paasche Price Index –

The paasche price index is one of the most important methods for tracking inflation in a basket of products and services by comparing current levels and quantities to prices from the previous year. The advantages of the index include:

  • It focuses on the economy’s consumption habits while taking into account the current level of available quantities.
  • It considers the complete basket of products and services, which includes both low-cost and high-cost items.
  • It reflects government policies on daily commodities and services because they are consumed by the general population every day and are what they care about the most.
  • Gives the government a trigger or a warning signal about growing prices and rising costs of living, which may stifle growth for a certain group of people.
  • Is a good parameter to frame the future policies that will control inflation.

Following are the disadvantages of Paasche Price Index:

  • Because the index already captures changes in consumption patterns when customers respond to price changes, it tends to understate price changes.
  • Does not take into account the changing taste and preferences of the people.
  • The index ignores the growing economy.
  • Extraction of data for current numbers accessible from multiple websites is extremely tough.

The paasche price index is a price index that measures the change in the prices and quantities of a basket of products and services through time in comparison to a predetermined base period price. A critical change in the Paasche Price Index will give a Warning Signal to the public authority Authorities that some move should be made for its Sudden increment or abrupt fall. A high expansion in the Index may go hindering to the Interest of the Common public to purchase the Essential Commodities at exorbitant costs.

The index’s numerator is total expenditures for all items during the observation period using observation period prices and quantities, while the denominator is total expenditures for all goods using base period prices and observation period quantities. The record is determined consistently to comprehend the pattern whether it is going in the vertical or the descending bearing alongside the vital advances or moves to be made to keep up something very similar. This record revises at the vertical cost inclination of the Laspeyres Price Index and furthermore mulls over utilization designs.

It does, however, rely on current data (which may not always be publicly available) and tends to understate price increases. This index is frequently used in economic activities and the finance ministry to keep track of inflation trends so that future plans and policies may be prepared with the Paasche Price Index Ratio calculated and its influence on the economy and the general public in mind.

Information Sources:

  1. wallstreetmojo.com
  2. corporatefinanceinstitute.com