Fixed Basket Laspeyres' Method Compared to Modified Laspeyres' Method in Computing Consumer Price Indices

This paper reviews Consumer Price Index (CPI) computation formula (Laspeyres’). The paper, specifically, compares two Laspeyres’ methods (the fixed basket and the modified one). It starts with the price index practical and economic theory point of view; and, simulates the formulae with some data to find out their behavior. The paper reviews various CPI documents from ILO, IMF and countries’ practices (specifically SADC countries) in computing their CPIs. It is found that the two formulae behave differently in relation to the underlying economic theories. The economic theory indicates that if the price of a current period is the same as that of a base period, the index number of this period will be equal to that of the base price period(100). In this case the inflation figure for such a period compared to the base period will be equal to zero, that is, there is no inflation. Additionally, index numbers computed for items with the same prices in two different current periods, results to the same index number. Wrong monetary and economic policies may be the outcomes of applying wrongly computed price index numbers and inflation figures. The paper concludes that consumer price index numbers computed from modified Laspeyres’ formula do not conform to the index and economic theories; and thus, lead to wrong inflation figures.