Laspeyres Method

The Laspeyres Price Index is a weighted aggregate price index, where the weights are determined by quantities in the base period. The formula for constructing the index is:
 
Steps.    
(i) Multiply the current year prices of various commodities with base year weights and obtain ∑p₁q₀.

(ii) Divide ∑p₁q₀ by ∑p₀q₀ and multiply the quotient by 100. This gives us the price index.

Laspeyres index attempts to answer the question: “What is the change in aggregate value of the base period list of goods when valued at given period prices?” This index is very widely used in practical work.

The primary disadvantages of the Laspeyres method is that it does not take into consideration the consumption pattern. The Laspeyres index has an upward bias. When prices increase, there is a tendency to reduce the consumption of higher prices items. Hence, by using base year weights, too much weight will be given to those items which have increased in price the most. Similarly, when prices decline, consumers shift their purchases to those items which decline most.

By using base period weights, too little weight is given to those items which decrease most in price, again overstating the index.

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