A house price index represents a certain 'typical' house or set of houses. The problem that arises is how to choose or define the 'typical' house. This can be done in one of two ways: according to number of transactions; or according to stock of properties. The two will vary because some property types change hands more frequently than others.
The other problem that arises is the issue of weighting. There are two possible approaches:
- Transaction Weighting or Volume Weighting. An index based on transaction weighting represents the price of a house with 'typical' characteristics; all the properties in the set have an equal weight in determining what is 'typical', irrespective of their price. This method is used when the index is constructed to represent the value of a typical member of the reference set.
- Expenditure Weighting. Using expenditure weighting, an index embodies the price of a representative set of properties, and the more expensive houses have a higher weight. This method is used when the price index is constructed to reflect the value of the housing stock.
Example: The average price of a detached house rises by 10 per cent, from £120,000 in 2002 to £132,000 in 2003. During the same period, the mean price of a terraced house falls by 10 per cent, from £80,000 to £72,000. If "volume weighting" is used, i.e. if each type possesses equal weight, the inflation rate would be zero. But this neglects the fact that the overall market value increases. If there are 100 houses of each type, the price of the entire stock increased from £2m in 2002 to £2.04m in 2003.
- Gregory Thwaites and Rob Wood, "The Measurement of House Prices" (Bank of England Quarterly Bulletin, Spring 2003).
- Simon Briscoe, "House Price Indices" (Significance, March 2004)