What’s a price index?

A price index is an economic time series that gives the percent change in prices for a collection of goods and services between a given point in time and a fixed reference point in time (i.e., the base period or reference period).1 A price index is usually represented so that subtracting 100 from the value of the index gives the percent change in prices for the goods and services captured by the index. For example, if a price index for widgets has a value of 110 in some period, then prices for widgets have increased by 10% since the base period. This representation also means that the index has a value of 100 in the base period.

The chart below gives an example of a monthly price index showing the change in prices in each month of the year with respect to January (the base period), so that each point on the graph gives the percent change in prices since January. For example, in March the index had a value of 103, meaning prices increased by 3% between March and January, whereas the index had a value of 99 in June, meaning prices decreased by 1% between January and June.

Since a price index only measures the relative change in prices since the base period, changing the scale of the index does not change its economic content. For example, dividing all values in the above chart by 100 does not change the shape of the graph, or the resulting percent change in the index value since the base period. It is for this reason that the magnitude of a price index does not give a measure of the price level at a point in time—a price index can only measure the change in prices over time.

The usefulness of a price index is that it gives a way to systematically condense information about many prices for a range of goods and services into a single value that measures the change in prices for these goods and services over time. Although which goods and services form the scope of a price index depends on its purpose, all price indices give a measure of aggregate price movements for a well-defined set of commodities. This in turn gives a measure of inflationary pressures in an economy, and consequently price indices are ubiquitous when examining macroeconomic conditions and policies.

  1. A price index can also be used to measure the difference in prices in different locations at the same point in time, although this is a less common use of a price index.↩︎