Laspeyres method, Financial Management

Assignment Help:

Laspeyres Method

Laspeyres method uses the quantities consumed during the base period in computing the index number. This method is also the most commonly used method which incidentally requires quantity measures for only one period. Laspeyres index can be calculated using the following formula:

Laspeyres Price Index = 1774_laspeyres method.png

where,     

P1 = Prices in the current year
P0  Prices in the base year
Q0 = Quantities in the base year

Laspeyres Index

454_laspeyres method1.png

In general, Laspeyres price index calculates the changes in the aggregate value of the base year's list of goods when valued at current year prices. In other words, Laspeyres index measures the difference between the theoretical cost in a given year and the actual cost in the base year of maintaining a standard of living as in the base year.

Also, Laspeyres quantity index can be calculated by using the formula,

 

Laspeyres quantity index 519_laspeyres method2.png

where,

Q1

=

 Quantities in the current year and Q0, P0 are as defined earlier.

Using the same data as provided in the above table, Laspeyres quantity index is

 

   =

2080_laspeyres method3.png =   122.96

A Laspeyres index is simpler in calculation and can be computed once the current year prices are known as the weights are base year quantities in a price index. This also enables easy comparability of one index with another. Interestingly, Laspeyres tends to overestimate the rise in prices or has an upward bias.

  • There is usually a decrease in the consumption of those items for which there has been a considerable price hike and the usage of base year quantities will result in assigning too much weight to prices that have increased the most and the net result is that the numerator of the Laspeyres index will be too large.

  • Similarly, when the prices go down, consumers tend to demand more of those items that have declined the most and hence the usage of base period quantities will result in too low weight to prices that have decreased the most and the net result is that the numerator of the Laspeyres index will again be too large.

This is a major disadvantage of the Laspeyres index.

However, the Laspeyres index remains most popular for reasons of its practicability. In most countries, index numbers are constructed by using Laspeyres formula.


Related Discussions:- Laspeyres method

Determine the concept of measuring the rate of return, Determine the concep...

Determine the concept of Measuring the Rate of Return The rate of return is total return the investor receives during holding period (the period when security is owned or held

Traditional yield measures, Current Yield Current y...

Current Yield Current yield is defined as the annual coupon interest received on the market price.          Current Yield =

Explain the significance of the term additional funds needed, Explain the s...

Explain the significance of the term additional funds needed . When the pro forma balance sheet is finished, total liabilities and total assets and equity will rarely match.

Accounting rate of return (arr), Accounting Rate of Return (ARR): This ...

Accounting Rate of Return (ARR): This technique relies on the rate of return every project will earn over its life. It takes the help of accounting profit while calculating the

Marshall-edgeworth method, Marshall-Edgeworth Method Marshall-Edgeworth...

Marshall-Edgeworth Method Marshall-Edgeworth method uses both the current year as well as the base year prices and quantities. Marshall-Edgeworth Index can be computed using th

Mr, discuss the applicability of financial management in respect to poultry...

discuss the applicability of financial management in respect to poultry farming in uganda

Swap-linked notes, Swap-Linked Notes: Interest rate swaps are derivativ...

Swap-Linked Notes: Interest rate swaps are derivative products which help in transforming the cash flows of existing debt issues. These are not only useful in covering the exis

Describe market value weights, Q. Describe Market Value Weights? Market...

Q. Describe Market Value Weights? Market Value Weights: - As per market worth scheme of weighting the weights to dissimilar sources of finance are assigned on the basis of thei

Calculate the wacc and irr, The capital structure of Wild West Inc. is as f...

The capital structure of Wild West Inc. is as follows: Debts: $5,000,000 (face value) bonds with coupon rate at 8.00% and current price at par Preferred shares: $2,000,000

Calculate the minimum price sell for in a rational market, Suppose spot Swi...

Suppose spot Swiss franc is $0.7000 and the six-month forward rate is $0.6950.  What is the minimum price which a six-month American call option along with a striking price of $0.6

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd