UNIT 11 INDEX NUMBER-III

Structure
11.0 Learning Objectives
11.1 Issues Involved
11.2 Usefulness of Index Numbers
11.3 Summary
11.4 Keywords
11.5 Learning Activity
11.6 Unit End Questions
11.7 References

11.0 LEARNING OJECTIVES

After studying this unit, students will be able to,

 Analyze the issues involved in Index Numbers

 Explain the usefulness of Index numbers

11.1 ISSUES INVOLVED

Following are some of the important criteria/problems which have to be faced in the
construction of index Numbers.
Selection of data: It is important to understand the purpose for which the index is used. If it
is used for purposes of knowing the cost of living, there is no need of including the prices of
capital goods which do not directly influence the living. Index numbers are often constructed
from the sample. It is necessary to ensure that it is representative. Random sampling, and if
need be, a stratified random sampling can ensure this.
It is also necessary to ensure comparability of data. This can be ensured by consistency in the
method of selection of the units for compilation of index numbers.
However, difficulties arise in the selection of commodities because the relative importance of
commodities keep on changing with the advancement of the society. More so, if the period is
quite long, these changes are quite significant both in the basket of production and the uses
made by people.
Base Period: It should be carefully selected because it is a point of reference in comparing
various data describing individual behaviour. The period should be normal i.e., one of the

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relative stability, not affected by extraordinary events like war, famine, etc. It should be
relatively recent because we are more concerned with the changes with reference to the
present and not with the distant past. There are three variants of the base fixed, chain, and the
average.
Selection of Weights: It is necessary to point out that each variable involved in composite
index should have a reasonable influence on the index, i.e., due consideration should be given
to the relative importance of each variable which relates to the purpose for which the index is
to be used. For example, in the computation of cost of living index, sugar cannot be given the
same importance as the cereals.
Use of Averages: Since we have to arrive at a single index number summarising a large
amount of information, it is easy to realise that average plays an important role in computing
index numbers. The geometric mean is better in averaging relatives, but for most of the
indices arithmetic mean is used because of its simplicity.
Choice of Variables: Index numbers are constructed with regard to price or quantity or any
other measure. We have to decide about the unit. For example, in price index numbers it is
necessary to decide whether to have wholesale or the retail prices. The choice would depend
on the purpose. Further, it is necessary to decide about the period to which such prices will be
related. There may be an average of price for certain time-period or the end of the period. The
former is normally preferred.
Selection of Formula: The question of selection of an appropriate formula arises, since
different types of indices give different values when applied to the same data. We will see
different types of indices to be used for construction succeeding.

11.2 USEFULNESS OF INDEX NUMBERS

1. As the indices are constructed mostly from deliberate samples, chances of errors creeping
in cannot be always avoided.
2. Since index numbers are based on some selected items, they simply depict the broad trend
and not the real picture.
3. Since many methods are employed for constructing index numbers, the result gives
different values and this at times create confusion.
4.Economic Parameters: The Index Numbers are one of the most useful devices to know the
pulse of the economy. It is used as an indicator of inflationary or deflationary tendencies.
5.Measures Trends: Index numbers are widely used for measuring relative changes over
successive periods of time. This enables us to determine the general tendency. For example,
changes in levels of prices, population, production etc. over a period of time are analysed.
6.Useful for comparison: The index numbers are given in percentages. So it is useful for
comparison and easy to understand the changes between two points of time.
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 Help in framing suitable policies: Index numbers are more useful to frame economic and
business policies. For example, consumer price index numbers are useful in fixing dearness
allowance to the employees.
7.Useful in deflating: Price index numbers are used for connecting the original data for
changes in prices. The price index is used to determine the purchasing power of monetary
unit.
In spite of its limitations, index numbers are useful in the following areas:
1.Framing suitable policies in economics and business. They provide guidelines to make
decisions in measuring intelligence quotients, research etc.
2.They reveal trends and tendencies in making important conclusions in cyclical forces,
irregular forces, etc.
3. They are important in forecasting future economic activity. They are used in time series
analysis to study long-term trend, seasonal variations and cyclical developments.
4. Index numbers are very useful in deflating i.e., they are used to adjust the original data for
price changes and thus transform nominal wages into real wages.
5. Cost of living index numbers measure changes in the cost of living over a given period.
Compares standard of living: Cost of living index of different periods and of different
places will help us to compare the standard of living of the people. This enables the
government to take suitable welfare measures.
Special type of average: All the basic ideas of averages are employed for the construction of
index numbers. In averages, the data are homogeneous (in the same units) but in index
number, we average the variables which have different units of measurements. Hence, it is a
special type of average

11.3 SUMMARY

 It is important to understand the purpose for which the index is used. It is necessary to
ensure that it is representative. The geometric mean is better in averaging relatives,
but for most of the indices arithmetic mean is used because of its simplicity. There are
three variants of the base fixed, chain, and the average. The former is normally
preferred, but the former is usually preferred.

 For. example, in price index numbers it is necessary. to decide whether to have

wholesale or the retail prices. The choice would depend on the purpose. Further, it is
needed to decide about the period to which such prices will be related.
 Index numbers are useful to frame economic and business policies. Cost of living
index numbers measure changes in the cost of living over a given period. They
provide guidelines to make decisions in measuring intelligence quotients. They reveal

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 trends and tendencies in making important conclusions in cyclical forces, irregular
forces, etc. They are important in forecasting future economic activity.
 They can be used in time series analysis to study long-term trend, seasonal variations
and cyclical developments. The price index is used to determine the purchasing power
of monetary unit. The index numbers are very useful in deflating. Index numbers are a
special type of average. They average variables which have different units of
measurements.

11.4 KEYWORDS

 Economic Parameters: The Index Numbers are one of the most useful devices to
know the pulse of the economy. It is used as an indicator of inflationary or
deflationary tendencies.

 Measures Trends: Index numbers are widely used for measuring relative changes
over successive periods of time. This enables us to determine the general tendency.
For example, changes in levels of prices, population, and production etc. over a period
of time are analyzed.

 Useful for comparison: The index numbers are given in percentages. So it is useful
for comparison and easy to understand the changes between two points of time.

 Useful in deflating: Price index numbers are used for connecting the original data for
changes in prices. The price index is used to determine the purchasing power of
monetary unit.

11.5 LEARNING ACTIVITY

1. Check from the newspapers and construct a time series of Sensex with 10 observations.
What happens when the base of the consumer price index is shifted from 1982 to 2000?

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11.6 UNIT END QUESTIONS

A. Descriptive Questions
Short Questions
1. Point out the difference between weighted and unweighted index numbers.
2. Define weighted index number.
3. What is circular test?
4. State the methods of constructing consumer price index.

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Long Questions
1. State the methods of weighted aggregate index numbers.
2. What is the difference between the price index and quantity index numbers?
3. Write short notes on consumer price index.

B. Multiple choice questions

1. The geometric mean of Laspeyre’s and Paasche’s price indices is also known as
a. Dorbish – Bowley’s price index
b. Kelly’s price index
c. Fisher’s price index
d. Walsh price index
2. The index number for 1985 to the base 1980 is 125 and for 1980 to the base1985 is 80. The
given indices satisfy
a. circular test
b. factor reversal test
c. time reversal test
d. Marshall-Edgeworth test

3. The consumer price index numbers for 1981 and 1982 to the base 1974 are 320 and 400
respectively. The consumer price index for 1981 to the base 1982 is
a. (a)80
b. (b)128
c. (c)125
d. 85

4. The consumer price index in 2000 increases by 80% as compared to the base 1990. A
person I 1990 getting Rs. 60,000 per annum should now get:
a. (a)Rs. 1,08,000 p.a.
b. (b)Rs. 1,02,000 p.a.
c. (c)Rs. 1,18,000 p.a.

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 d. Rs. 1,80,000 p.a.

Answer
1) c 2) c 3) a 4) a

11.7 REFERENCES

Textbooks / Reference Books

 T1: Levine, D., Sazbat, K. and Stephan, D. 2013. Business Statistics, 7thEdition,
Pearson Education, India, ISBN: 9780132807265.

 T2; Gupta, C. and Gupta, V. 2004. An Introduction to Statistical Methods,

23rdEdition, Vikas Publications, India, ISBN: 9788125916543.

 R1: Croucher, J. 2011. Statistics: Making Business Decisions, 13thEdition, Tata

McGraw Hill, ISBN: 9780074710419.

 R2 Gupta, S. 2011. Statistical Methods, 4thEdition, Sultan Chand & Sons, ISBN:
8180548627.

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