Measuring Changes in the Value of Money

Abstract

Index numbers are used to measure changes in particular aggregates. In the UK the most widely quoted index is the Index of Retail Prices, which measures changes in the price of a basket of goods which are purchased by the average consumer. In order to ensure that the basket reflects the importance of the different items purchased, each item in the basket is assigned a weight which reflects the frequency with which that item is purchased. This is important because the effect of a price change depends, not only on the extent of the price change, but also on the frequency with which an item is purchased. If the price of a light bulb rises by 50 per cent, this is far less significant than a 10 per cent rise in the price of milk because most people buy milk daily, whereas light bulbs are bought far less frequently. If all other things are equal, the more frequently a good is bought, the higher will be its weight to reflect its greater importance in the average family’s budget.