The use of indices A common way of measuring the effect of price changes is the use of a price index. To calculate the inflation rate over a particular period the following formula is used: Thus, if we wanted to calculate the inflation of retail prices in 1986 using the Retail Prices Index, the rate is: where 385.9 is the index for 1986 and 373.2 is the index for 1985. Price indices are published by the Central Statistical Office in its Annual Abstract of Statistics. It is worth noting how they are constructed. In a simple case the index will measure the increased price of a single homogeneous product. For instance, in calculating the cost of diesel fuel, the government will take a weighted average of the market prices. Outlets for diesel fuel that are more popular than others will be given a higher weight. For example, the price of the fuel sold next to a refinery might be especially low, but as not much is sold through this output, it would have a lower weighting than London diesel fuel prices. The prices are then converted into an index number as follows: The weighted 'typical' price of £161.5 is then compared to the price in the base year (which is arbitrarily given the index number 100). Suppose that the price in 1980 was L104.9. The amount by which our price is greater than the 1980 price is As 1980 is given the index number of 100, then our 1986 price should be 54 per cent higher, which is simply 154. A complex index relates to a whole range of goods. In the Retail Prices Index (RPI), for instance, each item considered in the index will have various prices throughout the country weighted as for diesel fuel, the weighted price for each product being considered will then, in turn, have to be weighted according to its popularity in the retail market. In the RPI, weights are given according to various sectors, e.g. food in 1986 was given a weight of 185/1,000 compared to tobacco of 40/1,000. Thus the typical consumer spent 18 per cent of his or her income on food and 4 per cent of his or her income on tobacco. In the case of the RPI, these weights are revised annually from the Family Expenditure Survey. The Tax and Price Index (TPI) is similar to the RPI, except that it includes changes to direct taxes (including National Insurance) as well as retail prices. The index measures the amount by which gross income would have to increase in order to maintain its real value in purchasing power. If, for instance, there is a rise in prices which is offset exactly by a fall in taxation for the average taxpayer, then there would be a rise in the RPI but no change in the TPI. The TPI was designed for use in wage negotiations. Whether it or RPI is used is a matter of who should benefit. In the case of tax cuts and inflation, the employer would benefit by using the TPI, as it would increase by less than the RPI. The employee might well feel that it is the employer rather than the employee who benefits from employee tax cuts by this method, for the employees' purchasing power would remain the same in spite of the tax cuts, whereas the employer's wage bill would decline in real terms. Where there are tax increases, the TPI will allow for the extra burden, but the RPI will not; the preferences of the employer and employee will thus be reversed. As well as the two retail indices, there are, as we have said, a host of producer price indices. Managers ought to be aware of the indices for the types of expenditure under their control, and this knowledge should be used for the prediction of future price levels in the planning process. The range of price indices is illustrated in Table 9.2. The pattern of price changes can differ markedly; although the most important factor will normally be the general price-level change, there are exceptions. In Table 9.2, for instance, the price of copper has little correlation with the general rate of inflation; the variation in car prices, on the other hand, has moved much more closely with the general rate.