What Are Price Indices

A price index is an average of the proportionate changes in the prices of a specified set of goods and services between two periods of time. The ratio of the price of a specific product in period t to the price in period 0 is described as a price relative. Price relatives are pure numbers that are independent of the units in which the quantities are measured and the prices are quoted. Most index numbers can be expressed as, or derived from, weighted averages of these price relatives, the various formulas differing from each other due to weights and form of averages used. The two most common indices are Laspeyres and Paasche. Both indices are defined as weighted averages of price relatives, the weights being the values of the individual [groups of] goods and/or services in one or the other of the two periods being compared.

It is far too costly to attempt to measure all transactions taking place in an economy. A sample of transactions must be used, thus, it is important that the sample is representative for all transaction that will transpire over the period of time specified. Representative samples will be discussed further below in the description of the different indices.