Final answer:
Economists calculate the price level using a basket of goods and create price indices to track changes over time. They select a base year with an index of 100 and convert other years' costs into index numbers for comparison.
Step-by-step explanation:
To calculate the price level, economists use a basket of goods approach, which includes a variety of items commonly purchased by individuals, businesses, or organizations. Tracking how the prices of these items change over time allows for an analysis of inflation or deflation. Since an average of prices does not account for relative importance of goods, economists instead create price indices. These indices help by showing the average change in relative prices, giving a clearer picture of economic trends without being skewed by items that are more significant in the consumer's budget.
To simplify the interpretation, economists might take a not so straightforward messy-looking number and convert it to an index number by selecting a base year. The base year is always assigned an index number of 100, and prices in other years are adjusted accordingly to create a standardized comparison. For instance, if the base year's basket cost is $107, that year's index is 100. Prices from other years are divided by the cost in the base year and then multiplied by 100 to calculate their respective index numbers, allowing for unit-less and easily comparable figures.