Method of averaging relatives
Also called: Simple average of price relatives · Topic: Inflation and Index Numbers: CPI, WPI, IIP and the Deflator · NCERT: Class 11, Ch 7 "Index Numbers"
Meaning
The method of averaging relatives builds an index in two steps. First, find the price relative of each good. A price relative is its current price as a percentage of its base price. Then take the simple average of these relatives.
Formula: Index = (1/n) Σ(p₁/p₀) × 100, where n is the number of goods.
It fixes one weakness of adding up raw prices: prices in different units (per kg, per litre) no longer distort the result. But it is unweighted. Salt counts as much as food.
Example
Four goods have price ratios (p₁/p₀) of 2, 1.2, 1.25 and 1.5. The index is ¼ × (2 + 1.2 + 1.25 + 1.5) × 100 = 149. On average, prices rose 49%.
Don't confuse with
- Weighted index of price relatives: it uses the same relatives but weights them, usually by base-period expenditure shares (ΣWR/ΣW). With the same four goods and weights of 40, 30, 20 and 10, it gives 156, not 149.
Related concepts
- Index number
- Price index
- Quantity index
- Simple aggregative price index
- Weighted index
- Weighted aggregative price index
- Laspeyres price index
- Paasche price index
- Price relative
- Weighted index of price relatives