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Introduction

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Index numbers are meant to study the change in the effects of such factors which cannot be
measured directly. According to Bowley, “Index numbers are used to measure the changes in
some quantity which we cannot observe directly”. For example, changes in business activity in a
country are not capable of direct measurement but it is possible to study relative changes in
business activity by studying the variations in the values of some such factors which affect
business activity, and which are capable of direct measurement.

Index numbers are commonly used statistical device for measuring the combined

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fluctuations in a group related variables. If we wish to compare the price level of consumer items

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today with that prevalent ten years ago, we are not interested in comparing the prices of only one

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item, but in comparing some sort of average price levels. We may wish to compare the present

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agricultural production or industrial production with that at the time of independence. Here

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again, we have to consider all items of production and each item may have undergone a different
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fractional increase (or even a decrease). How do we obtain a composite measure? This composite
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measure is provided by index numbers which may be defined as a device for combining the
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variations that have come in group of related variables over a period of time, with a view to
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obtain a figure that represents the ‘net’ result of the change in the constitute variables.
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Index numbers may be classified in terms of the variables that they are intended to measure. In
business, different groups of variables in the measurement of which index number techniques are
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commonly used are (i) price, (ii) quantity, (iii) value and (iv) business activity. Thus, we have
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index of wholesale prices, index of consumer prices, index of industrial output, index of value of
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exports and index of business activity, etc. Here we shall be mainly interested in index numbers
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of prices showing changes with respect to time, although methods described can be applied to
other cases. In general, the present level of prices is compared with the level of prices in the past.
The present period is called the current period and some period in the past is called the base
period.

Index Numbers:
Index numbers are statistical measures designed to show changes in a variable or group
of related variables with respect to time, geographic location or other characteristics such as
income, profession, etc. A collection of index numbers for different years, locations, etc., is
sometimes called an index series.

Simple Index Number:
A simple index number is a number that measures a relative change in a single variable
with respect to a base.

Composite Index Number:
A composite index number is a number that measures an average relative changes in a
group of relative variables with respect to a base.

Types of Index Numbers:

Following types of index numbers are usually used:
Price index Numbers:
Price index numbers measure the relative changes in prices of a commodities between
two periods. Prices can be either retail or wholesale.

Quantity Index Numbers:
These index numbers are considered to measure changes in the physical quantity of
goods produced, consumed or sold of an item or a group of items.

Uses of Index Numbers

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The main uses of index numbers are given below:

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• Index numbers are used in the fields of commerce, meteorology, labour, industrial, etc.

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• The index numbers measure fluctuations during intervals of time, group differences of
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geographical position of degree etc.
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They are used to compare the total variations in the prices of different commodities in
which the unit of measurements differs with time and price etc.
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• They measure the purchasing power of money.
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• They are helpful in forecasting the future economic trends.
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• They are used in studying difference between the comparable categories of animals,
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persons or items.

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Index numbers of industrial production are used to measure the changes in the level of
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industrial production in the country.

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Index numbers of import prices and export prices are used to measure the changes in the
trade of a country.
• The index numbers are used to measure seasonal variations and cyclical variations in a
time series.

Limitations of Index Numbers

• They are simply rough indications of the relative changes.
• The choice of representative commodities may lead to fallacious conclusions as they are
based on samples.
• There may be errors in the choice of base periods or weights etc.
• Comparisons of changes in variables over long periods are not reliable.
• They may be useful for one purpose but not for other.
• They are specialized types of averages and hence are subject to all those limitations with
which an average suffers from.

Unweighted Index Numbers

There are two methods of constructing unweighted index numbers. (1) Simple Aggregative Method
(2) Simple Average of Relative Method

Simple Aggregative Method:
In this method, the total of the prices of commodities in a given (current) years is divided by the total
of the prices of commodities in a base year and expressed as percentage.

Simple Average of Relatives Method:
In this method, we compute price relative or link relatives of the given commodities and then use one
of the averages such as arithmetic mean, geometric mean, median etc. If we use arithmetic mean as average,

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then

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The simple average of relative method is very simple and easy to apply is superior to simple

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aggregative method. This method has only disadvantage that it gives equal weight to all items.
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Example:
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The following are the prices of four different commodities for and . Compute a price
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index by (1) Simple aggregative method and (2) Average of price relative method by using both arithmetic
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mean and geometric mean, taking as base.
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Commodity Cotton Wheat Rice Gram
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Price in

Price in

Solution:
The necessary calculations are given below:

Price Price in Price Relative
Commodity in

Cotton

Wheat

Rice
Gram

Total

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(1) Simple Aggregative Method:

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(2) Average of Price Relative Method (using arithmetic mean):

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Average of Price Relative Method (using geometric mean)
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Weighted Index Numbers
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When all commodities are not of equal importance. We assign weight to each commodity relative to
its importance and index number computed from these weights is called weighted index numbers.

Laspeyre’s Index Number:
In this index number the base year quantities are used as weights, so it also called base year
weighted index.

Paasche’s Index Number:
In this index number, the current (given) year quantities are used as weights, so it is also called current year
weighted index.

Fisher’s Ideal Index Number:
Geometric mean of Laspeyre’s and Paasche’s index numbers is known as Fisher’s ideal index number. It is
called ideal because it satisfies the time reversal and factor reversal test.
Marshal-Edgeworth Index Number:
In this index number, the average of the base year and current year quantities are used as weights.
This index number is proposed by two English economists Marshal and Edgeworth.

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Example:
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Compute the weighted aggregative price index numbers for with as base year using (1)
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Laspeyre’s Index Number (2) Paashe’s Index Number (3) Fisher’s Ideal Index Number (4) Marshal
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Edgeworth Index Number.
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Prices Quantities
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Commodity
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Solution:

Prices Quantity

Commodity
Laspeyre’s Index Number

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Paashe’s Index Number

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Fisher’s Ideal Index Number
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Marshal Edgeworth Index Number
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