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I looked at the notes for F2, but I couldn’t find a clear explanation. I also watched your lecture, but I would like to make it clear.
How does the Laspeyre index tend to overstate inflation and the Paasche index understate inflation?
With the Laspeyre overstating inflation, is it because you use the same quantity each year but different prices? If so, how does that overstate inflation?
How about Paasche?
Thank you!
If the price of something increases, then people are likely to buy less of that item. So the overall effect of the price increase on them is likely to be lower.
Laspeyre assumes they continue to buy the same quantities as in the base year.
Paasche uses the current quantities and therefore the price rise will have less affect on the overall cost of the ‘basket’.
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