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TheMathematicsoftheNationalHighwayConstructionCostIndex
ThisdocumentspecifiesthemethodologywhichservesasthebasisforthedevelopmentoftheNationalHighwayConstructionCostIndex,(NHCCI).

GeneralMethodologyforCalculatingtheNHCCI
TheFisherIdealIndexformulaisappliedusingachaintypeindexingmethodologytoproducetheNHCCI.Thespecificimplementationandreasonsfor
choosingthisspecificationaregiveninthissection.

Step1.Definitionofpriceindex
Thepriceindex,It,ofaspecificcostitemofhighwayconstruction(suchascement)givesthepriceofthatiteminperiodt,(pt),relativetermtoitspricein
referenceperiod0,(p0).ThemathematicalexpressionofItis:
(1)
Where,crepresentsthecostoftheitemandqrepresentsthequantityoftheitem.

Step2.Aggregatingindividualcostitemsintoatotalconstructioncostindex
Forhighwayconstructionasawhole,however,thedirectprice(p)doesnotexistbecausethepriceistheproductofcostdividedbyquantityandthequantities
ofhighwayconstructioncostitemsaremeasuredindifferentunitswhicharenotdirectlycomparableandnotadditive.Therefore,wecannotcalculatetheprice
indexofhighwayconstructionasawholebydirectlyimplementingequation(1).
Onenaturalwaytoderivethepriceindexofhighwayconstructionasawholeistocalculateitastheweightedaverageofpriceindexesofindividualcostitems.

(2)

Where,superscriptnrepresentthenthcostitemandwnrepresentstheweightassignedtothenthcostitem.

Step3.Choiceofindexformula
Asequation(2)shows,theaggregatepriceindexforhighwayconstructionasawholenotonlydependsonthepriceindexesoftheindividualcostitemsof
highwayconstruction,butalsodependsontheweightsassignedtotheindividualpriceindexes.Therefore,howtoweighttheindividualpriceindexesis
essentialincalculatinganaggregatepriceindex,suchastheNHCCI.Thechoiceofweightsalsoleadstothechoiceofindexformula.
Intheeconomicindexliterature,therearethreewellknownindexformulas.TheyaretheLaspeyresIndex,thePaascheIndexandtheFisherIdealIndex.In
equationform,theyare:

(3)

(Laspeyrespriceindex)

(4)

(Paaschepriceindex)

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(5)

(Fisherpriceindex)

Allthreepriceindexformulasusequantitiesofindividualcostitemsasweightstotheirrespectivepricesincalculatingtheaggregatepriceindex.However,the
Laspeyrespriceindexformulausesquantitiesofthebaseperiod(0)asweights,whilethePaaschepriceindexformulausesquantitiesofthecurrentperiod(t)
asweights.TheFisherpriceindexisageometricmeanoftheLaspeyrespriceindexandthePaaschepriceindex.
Despiteitsmanyobviousadvantages,theLaspeyrespriceindexhasitslimitations.Oneofthelimitationsisthatitusuallyoverstatestheimpactofprice
increasesandunderstatestheimpactofpricedecreasesasthecurrentperiodmovesfurtherawayfromthebaseperiod.Thisoccursbecauseofthe
substitutioneffectwhenpriceschangeinrelativeterms.Agentssubstituteawayfromgoodswhoserelativepricesincreasesothatthebaseyearweights
overstatetherelativeimportanceofthesegoodsinthebudget.Asaresult,theuseofquantitiesfromanearlierperiodasweightssystematicallybiasesthe
aggregatepriceindexupwardfromtherealchangeinaggregateprice.Incontrast,anaggregatepriceindexderivedfromthePaaschepriceindexformulais
usuallybiaseddownwardduetothesubstitutioneffect.
AsecondlimitationoftheLaspeyresindexasitisoftenimplementedisthatastimegoesonthefixedbaseyearbecomelessrelevanttothecurrentyearorthe
year(s)ofconcern.However,ifthebaseyearisshiftedforwardintime,theentireindexserieswillbechanged.Inotherwords,historywillberewrittenevery
timethebaseyearischanged.
TheFisherIdealindex,proposedbyIrvingFisherin1922,isoneofthesuperlativeindexesthatgivegoodapproximationstothetheoreticalor"exact"costof
livingindexandyetarerelativelysimpletocomputeanduse.ComparedtofixedweightedLaspeyresorPaascheIndexes,FisherIdealindextakestheweights
ofboththebaseperiodandthecurrentperiodintoaccount.Bydoingso,FisherIdealindexhastheabilitytoaccommodatetheeffectsofsubstitutions,
somethingtheLaspeyresandPaascheindexesdonotdo.AmajoradvantageofFisherIdealindexoverothersuperlativeindexes,suchastheTornquvistindex,
isits"dual"property,i.e.aFisherIdealpriceindeximpliesaFisherIdealquantityindex,andviceversa.Inotherwords,theproductofaFisherIdealpriceindex
betweentwoperiodsandaFisherIdealquantityindexbetweenthesametwoperiodsisequaltothetotalchangeinvalue(measuredincurrentdollars)between
thosetwoperiods.
AlltheseadvantagesstronglysuggestthattheFisherIdealindexformulaisanexcellentchoiceforbuildingtheNHCCI.

Step4.Calculatingaggregatepriceindexfortwoadjacentperiods
SincetheOSIBidTabsdatabaseprovidesdataonbidvalueandbidquantityandestimatedbidpricedataforeachcostitemofhighwayconstructionsinthe
UnitedStates,wecanapplytheFisherIdealIndexformulatothebidquantityandestimatedbidpricedatafromBidTabsdataatthecostitem(orPayItem)
leveltocalculatetheNHCCI.
However,eachtimewhentheFisherIdealIndexformulaisappliedtothepriceandquantitydata,oneandonlyoneindexnumberwillbegeneratedforthetwo
timeperiodsthedatarepresent.Inotherwords,theformulawillnotgenerateapriceindexseriesatonce.Thetimeperiodcanbeamonth,aquarter,orayear
andisusuallydeterminedbythedataavailability.Anindexnumbercanbegeneratedbetweenanytwoperiodsintime.Thetwoperiodscanbeadjacenttoeach
other.Theyalsocanbefarawayfromeachotherwithmanyperiodsbetweenthem.However,inordertobuildanindexthataccuratelytrackpricechangesfrom
oneperiodtothenextovertime,itwillbenecessarytogenerateanindexnumberforeverypairofadjacentperiodsoftheentiretimeperiodforwhichanindex
isbuild.

Step5.Chainindexnumbersofadjacentperiodsintoatimeseriesofindexes
Let

:
:
:

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Fromtheequations,wecanseethattheR1istheindexnumberofperiod(1)relativetoperiod(0)R2istheindexnumberofperiod(2)relativetoperiod(1)and
Rtistheindexnumberofperiod(t)relativetoperiod(t1)andthateachindexnumberpresentstheaggregatepriceofthecurrentperiodinrelativetermtothe
aggregatepriceofthepreviousperiod.Mathematicianscallthiskindofindexingrelativeindexing.Inrelativeindexing,anindexnumberhighlightsthechangein
pricefromtheadjacentpreviousperiod.
However,toshowpricechangesovertime,itwillbemoreeffectivetocomparethepriceofeachperiodtothepriceofthebaseperiod.Whenanindexis
calculatedbycomparingtheconcernedperioddirectlytothebaseperiod,itiscalled"directindexing".Theprocedureofdirectindexingisadualprocess.That
is,whilethepriceoftheconcernedperiodisindexedintermsrelativetothepriceofthebaseperiod,thepriceofthebaseperiodisalsoindexedto1andonly1.
Therefore,thevalueofadirectindexisalwaysintermsrelativeto1andequaltothechangebetweenthetwoperiods.Thispropertyprovidesthemathematical
underpinningforthe"chain"indexprocedure.
Whenthepriceofthebaseperiod(0)isindexedto1,thechainedindexnumbers,I1forperiod(1),I2forperiod(2),,andItforperiod(t),canbecalculatedas:
(9)

Inwords,thechainedindexnumberofanyperiod(tothebaseperiod)canbecalculatedastheproductoftheconsecutivemultiplicationofthechangesofthe
adjacentperiodsbetweenthebaseperiodandthatperiod.Forexample,withthechaintypeprocedureandannualratesofchanges(Rt),theindexofyear1995
toyear1990(I90,95)canbecalculatedas:

Summary
Insummary,theChainedFisherIdealIndexmethodforbuildingtheNHCCIcontainstwosteps.Inthefirststep,FisherIdealIndexformulaisusedtocalculate
changesinaggregatepricebetweenadjacentperiodswithbidquantityandestimatedbidpricedataatthecostitem(orPayItem)levelfromOmanBidTabs
databaseasinputs.Thisstepisalsoanaggregationprocess.Changesinaggregatepriceofhighwayconstructionasawholecalculatedinthiswayare
essentiallytheaveragesofquantityweightedchangesinthepricesofthecostitemsofhighwayconstruction.Inthesecondstep,changesinaggregateprice
betweenadjacentperiodsarechainedtogetherthroughconsecutivemultiplicationtoformatimeseriesofaggregatepriceindexforhighwayconstructionasa
whole.
TheChainedFisherIdealIndexmethodrecognizestheneedforestimatingchangesintheaggregatepriceofhighwayconstructionasawholetouseweights
thatarerelevantandappropriateforthespecificperiodsbeingmeasured.TheChainedFisherIdealIndexmethodhasthreeimportantadvantagesoverFixed
WeightedIndexes.First,whileitmakesaggregationofpricechangesinmanyanddifferentcostitemsintoonemeasurethroughweighting,itcapturesthe
effectsofchangesintherelativeimportanceofdifferentcostitemsinhighwayconstructionovertime.Second,itminimizessubstitutionbiasand,atthesame
time,providesamoreaccuratetrackofpricechangesinhighwayconstructioncostitemsasawhole.Third,iteliminatestheinconvenienceandconfusion
associatedwithFixedWeightedIndexesofupdatingtheweightsandbaseperiods,andthusrewritingeconomichistory,asbaseperiodsmovefurtherand
furtherintothepastandbecomemoreandmoreirrelevanttothecurrent.

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