INDEX

NUMBERS
 INTRODUCTION
• Index numbers are statistical devices designed to
measures the relative change in price, quantity, value, or
some other item of interest from one time period to
another. In other words they are the nos. which express
the value of a variable at any time, called the Given period
as the percentage of value of that variable at some
standard time, called the Base period.

• A simple index number measures the relative change in

one or more than one variable.
• Index numbers are the indicators which reflect changes
over a specified period of time in prices of different
commodities, industrial production, sales, imports and
Exports, cost of living index, etc.
These indicators are of paramount importance to the
management personnel or any government organisation
or industrial, for the purpose of reviewing position and
planning action ,if necessary, in the formulation of
Executive decisions.
Uses of Index Numbers
Index numbers possess much practical importance in measuring changes
in the cost of living, production trends, trade, income variations, etc.
Some of the uses of index numbers are discussed below:
1. In Measuring Changes in the Value of Money: Index number are
used to measure changes in the value of money. A study of the rise or
fall in the value of money is essential for determining the direction of
production and employment to facilitate future payments and to know
changes in the real income of different groups of people at different
places and times.
2. In Cost of Living: Cost of living index numbers in the case of different
groups of workers throw light on the rise or fall in the real income of
workers. It is on the basis of the study of the cost of living index that
money wages are determined and dearness and other allowances are
granted to workers. The cost of living index is also the basis of wage
negotiations and wage contracts.
3. In Analysing Markets for Goods and Services: Consumer price
index numbers are used in analysing markets for particular kinds of
goods and services. The weights assigned to different commodities like
food, clothing, fuel, and lighting, house rent, etc., govern the market
for such goods and services.
4. In Measuring Changes in Industrial Production: Index
numbers of industrial production measure increase or decrease in
industrial production in a given year as compared to the base year. We
can know from such as index number the actual condition of different
industries, whether production is increasing or decreasing in them,
for an industrial index number measures changes in the quantity of
production.
5. In Internal Trade: The study of indices of the wholesale prices of
consumer and industrial goods and of industrial production help
commerce and industry in expanding or decreasing internal trade.
6. In External Trade: The foreign trade position of a country can be
assessed on the basis of its export and import indices. These indices
reveal whether the external trade of the country is increasing or
decreasing.
7. In Economic Policies: Index numbers are helpful to the state in
formulating and adopting appropriate economic policies. Index
numbers measure changes in such magnitudes as prices, incomes,
wages, production, employment, products, exports, imports, etc.
By comparing the index numbers of these magnitudes for different
periods, the government can know the present trend of economic
activity and accordingly adopt price policy, foreign trade policy and
general economic policies.
8. In Determining the Foreign Exchange Rate: Index numbers of
wholesale price of two countries are used to determine their rate of
foreign exchange. They are the basis of the purchasing power parity
theory which determines the exchange rate between two countries on
inconvertible paper standard.
Problems in the Construction of
Index Numbers
In constructing an index number, the following
Steps (problems) should be noted:
 Purpose of index numbers
 Selection of commodities
 Data for index numbers
 Selection of Base period
 Type of average used
 Selection of appropriate weights
 Choice of formula
1. Purpose of the Index Number:
An index number is properly design for a purpose can be most useful
and powerful tool otherwise it can be equally misleading and
dangerous. the first and the foremost problem is to determine the
purpose of index number without which it is not possible to follow the
steps in its construction.
Before constructing an index number, it should be decided the purpose
for which it is needed. An index number constructed for one category or
purpose cannot be used for others. A cost of living index of working
classes cannot be used for farmers because the items entering into their
consumption will be different.
2. Selection of Commodities:
Commodities to be selected depend upon the purpose or objective of
the index number to be constructed. But the number of commodities
should neither be too large nor too small. Moreover, commodities to be
selected must be broadly representative of the group of commodities.
They should also be comparable in the sense that standard or graded
items should be taken. The selection of commodities should be by
judgemental sampling and not by random sampling.
3. Data for Index Numbers:
The data, usually the set of prices and of quantities consumed of the
selected commodities for different periods, places, etc constitute the
raw material for construction of index numbers. The data should be
collected from reliable sources such as standard trade generals, Official
Publications, periodicals, Special report from producers, exporters or
through field agency
4. Selection of the Base Period:
The selection of the base period is the most important step in the
construction of an index number. It is a period against which
comparisons are made. The base period should be normal and free from
any unusual events such as war, famine, earthquake, drought, boom,
etc. It should not be either very recent or remote.
 Suppose we want to compare the price level of two time periods, say the price level
of 1990 with that of 1980, we call the year 1990 as the current period and the year
1980 as base period. The period with which the comparison of the
relative changes are made is termed as base period and the index for this period
is always taken as 100. The following are the Criterion for choice of base period:
The base period should be a normal period:
By normal period we mean that the period should not be subjected to a depression
or effects of catastrophes like war, floods, famines, earthquake, etc. If the base
period is taken as period of economic instability or depression in which prices of
various commodities and goods, due to their scarcity have been abnormally high
then the comparison of price relative in any given year will not be of much
practical utility.
The base period should not be too short or long:
It should not be too short, for e.g., a single day or week because the prices for short
periods are highly unstable and unreliable and again it should not be too long from
given period, as it is possible that the pattern of consumption of commodities may
change appreciably.
5. Type of Average used:
Since index numbers are averages, the problem is how to select an appropriate
average. The two important averages are the arithmetic mean and geometric
mean. The arithmetic mean is the simpler of the two. But geometric mean is more
accurate. However, the average prices should be reduced to price relatives
(percentages) either on the basis of the fixed base method or the chain base
method.
6. Selection of Appropriate Weights:
While constructing an index number due weightage or importance should be
given to the various commodities. Commodities which are more important in the
consumption of consumers should be given higher weightage than other
commodities. The weights are determined with reference to the relative amounts
of income spent on commodities by consumers. Weights may be given in terms of
value or quantity.
7. Choice of Formula:
A number of formulae have been devised to construct an index number. But the
selection of an appropriate formula depends upon the availability of data and
purpose of the index number. No single formula may be used for all types of index
numbers.