Uses of Index Number of Prices:

Index numbers may be constructed for indicating the average changes generally with regard to a wide
range of business or economic activities or may be constructed to indicate changes as to one or a few
aspects of business or economic activities. A general index number of price covering all goods and
services no doubt will serve a useful purpose in analysing economic and business activities

The importance or the uses of index numbers of prices are listed:

(a) Measures Changes in Price Level and Standard of Living:

Index number of prices is a method through which we can measure changes in the price level over time.
This means that whether a country faces inflation or deflation can be known from the index number of
prices. Thus, it helps to determine the changes in the economic conditions of people.

Inflation reduces standard of living while deflation increases living standards. However, this statement is
too simplistic and ignores many aspects. Anyway, as the price index changes, per capita income changes.
A change in per capita income causes a change in the standard of living.

(b) Regulation of Wage Rate:

Salaries and wages and dearness allowances are revised by the government when price level changes.
Higher wages and dearness allowances are often given by the appropriate authorities when index
numbers of prices rise so as to protect the real income of the workers.

In other words, a fall in real income consequent upon a rise in price level measured by the index
numbers of prices is compensated in the form of higher wages and dearness allowances. Cost of living
index can be made a basis for the regulation of wage rates and other allowances.

(c) Determination of Government Policies:

Index numbers of prices serve as guide to government policies. The price stability objective of the
government policy is based on index numbers. It formulates policies to control inflation and deflation.
Index numbers also enable governments to explain their population policies, agricultural and industrial
policies, taxation policy, etc.In addition, index numbers serve as a guide to the central bank (i.e.,
monetary authority) to take appropriate action against price changes.

(d) Guide for Businessmen:

Index numbers also serve as a guide to businessmen. Rising prices as indicated by index numbers may
create an atmosphere of optimism. Now these people will be interested in investing more to have larger
profit. Opposite reaction follows when prices fall.

(e) International Comparisons:

An index number facilitates international comparisons of economic variables. For instance, we want to
make comparisons in living standards between different nations. We then construct real per capita of
incomes of different nations on the basis of index numbers of prices. Thus, index numbers measure the
levels of development of different countries.