An electric vehicle (EV) manufacturer is analyzing the cost of raw materials (lithium, cobalt, nickel) over a 3-year period using index numbers.

Which of the following statements regarding Laspeyres and Paasche indices are correct? (Select all that apply)

Answer options:

The Laspeyres price index uses base year quantities as weights.

The Paasche price index uses current year quantities as weights.

The Laspeyres index tends to understate inflation compared to Paasche.

The Paasche index is generally cheaper and easier to calculate every year than Laspeyres.

How to approach this question

Recall the definitions: Laspeyres = Base quantities. Paasche = Current quantities. Think about the practical implications of gathering new data every year.

Full Answer

The Laspeyres price index weights prices using base-year quantities (Σp1q0 / Σp0q0). The Paasche price index uses current-year quantities (Σp1q1 / Σp0q1). Because Laspeyres uses fixed base quantities, it ignores the fact that buyers will substitute away from more expensive goods, thus it tends to overstate inflation. Paasche requires new quantity data every year, making it more expensive and time-consuming to calculate.

Common mistakes

Thinking Laspeyres understates inflation or that Paasche is easier to calculate.

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