A price index is a measured number used to compare price levels over time. It tracks and quantifies the average change in prices of a predetermined basket of representative goods and services.
- Common indexes include the Consumer Price Index (CPI), Producer Price Index (PPI), and GDP deflator
- A base year is assigned an index value of 100, with subsequent years measured relative to the base year
- Provides a macro-level view of overall inflation or deflation trends over time
The key strengths of a price index are its ability to simplify complex price movements into a single statistic and support comparative economic analysis across time periods.
Potential limitations include biases that can arise from changes in the basket composition over time as consumption patterns evolve. Substitution effects also occur as consumers adjust purchases in response to relative price changes.
Price indexes guide policymaking decisions around monetary policy, incomes policies, and tax measures. Businesses also utilize indexes for targeted pricing strategies, negotiating wages and salaries, and managing supply chains.
While not a perfect measure, price indexes nonetheless offer valuable normalized data to help evaluate purchasing power, cost of living changes, and related economic trends across different industries, locations, and timeframes.