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

What is the ratios based on historic cost accounts, What is the Ratios base...

What is the Ratios based on historic cost accounts Ratios based on historic cost accounts don't give a true picture of trends, due to the effects of inflation and different acc

Budget classification on the basis of time, ON THE BASIS OF TIME • Lon...

ON THE BASIS OF TIME • Long term budget :  as per the National Association of Accountants, America, a long term budget is a systematic and formalized process for purposeful co

International strategic management, undertake a critical review of the curr...

undertake a critical review of the current academic literature to determine the reasons for benefits of and the costs to companies of cross listing.

#WACC, Filer Manufacturing has 8.9 million shares of common stock outstandi...

Filer Manufacturing has 8.9 million shares of common stock outstanding. The current share price is $59, and the book value per share is $4. Filer Manufacturing also has two bond is

Importance of capital budgeting decision, Q. Importance of Capital Budgetin...

Q. Importance of Capital Budgeting Decision? 1. Such Decision affect the profitability of the Firm: - Capital Budgeting decision influences the long-term profitability of a fir

Discounting the expected cash flows in valuation process, After deter...

After determining the expected cash flows and appropriate interest rate, the last step in the valuation process is to find the total PV of all cash flows. The PV

Explain hedging transaction exposure, Discuss and compare hedging transacti...

Discuss and compare hedging transaction exposure by using the forward contract vs. money market instruments. While do the alternative hedging approaches generate similar result?

Margining system, Margining System: Indian capital markets have finally...

Margining System: Indian capital markets have finally acquired an international flavor with the market-wide rolling settlement coming into place on both the premier exchanges (

Determine about the entity level - inherent risk, At entity level - Inheren...

At entity level - Inherent risk Integrity of management. Management's experience and knowledge Over reliance on key customers. Unusual pressures on management

Micro/Macro Question, You have been hired as an economic advisor to the Sou...

You have been hired as an economic advisor to the Southeastern Conference. As your first assignment they have asked you to identify three microeconomic and three macroeconomic issu

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