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What is a Base Year?
To convert the money spent on the basket to an index number, economists arbitrarily choose one year to be the base year, or starting point from which we measure changes in prices. The base year, by definition, has an index number equal to 100. This sounds complicated, but it is really a simple math trick. In the example above, say that we choose time period 3 as the base year. Since the total amount of spending in that year is $107, we divide that amount by itself ($107) and multiply by 100. Again, this is because the index number in the base year always has to have a value of 100. Then, to figure out the values of the index number for the other years, we divide the dollar amounts for the other years by 1.07 as well. Note also that the dollar signs cancel out so that index numbers have no units.
Because we calculate the index numbers so that they are in exactly the same proportion as the total dollar cost of purchasing the basket of goods, we can calculate the inflation rate based on the index numbers, using the percentage change formula.
Related Topics
- Inflation
- Core Inflation
- Cost Push Inflation
- Demand Pull Inflation
- Wage Push Inflation
- Inflation Spiral (Wage-Price Spiral)
- Agflation
- Basket of Goods and Services
- Indexing and Index Number
- Base Year
- Consumer Price Index
- Substitution Bias
- Quality / New Goods Bias
- Core Inflation Index
- Producer Price Index
- International Price Index
- Employment Cost Index
- Buying Power Index
- Breakfast Index
- Employment Cost Index
- Producer Price Index
- Capital Goods Price Index
- Farm (Agricultural) Price Index
- Harmonized Index of Consumer Prices
- Repeated Sales Method (Real Estate)
- GDP Deflator
- Deflation
- Pigou Effect
- Hyperinflation (Economics)
- Biflation
- Inflation and Redistribution of Purchasing Power
- Inflation Blurs Price Signals
- Inflation Affects Long-Term Planning
- What are the Benefits of Inflation?
- Indexing and Index Number
- Cost of Living Allowance
- Adjustable Rate Mortgage