INTRODUCTION TO INDEX

NUMBERS AND ITS

CONSTRUCTION
-AML
DEFINITION OF INDEX NUMBERS
CHARACTERISTICS
USEFULNESS
ISSUES INVOLVED
TYPES
METHODS OF CONSTRUCTION
CAUTIONS AND LIMITATIONS
DEFINITION:

An index number is a statistical measure

designed to show changes in variable or a
group or related variables with respect to
time, geographic location or other
characteristics such as income, profession,
etc.
DEFINITION:

An index number is a ratio or an average of

ratios expressed as a percentage, two or more
time periods are involved, one of which is the
base time period. The value at the base time
period serves as the standard point of
comparison.

An index time series is a list of index numbers for

two or more periods of time, where each index
number employs the same base year.
“Index numbers are quantitative
measures of growth of prices,
production, inventory, and other
quantities of economic interest.”
-Ronold
CHARACTERISTICS:

These are expressed as percentage

Index numbers are specialized
averages
Index numbers measures changes
that are not directly measurable
 USEFULNESS OF INDEX NUMBERS:
Framing suitable policies in economics and business.
They reveal trends and tendencies in making
important conclusions in cyclical forces, irregular
forces, etc.
They are important in forecasting future economic
activity.
Index numbers are very useful in deflating
Cost of living index numbers measure changes in the
cost of living over a given period.
ISSUES INVOLVED:

Selection of data
Base Period
Selection of Weights
Use of Averages
Choice of Variables
Selection of Formula
TYPES OF INDEX NUMBERS:

Price index
Quantity index
Value Index
CONSTRUCTION OF
INDEX NUMBER
METHODS OF CONSTRUCTING INDEX NUMBERS

Two approaches:
Aggregates method
Average of Relatives method
Note:The index constructed in either of
these methods could be:
Unweighted index
 an index where equal weights are implicitly assigned

Weighted index
 an index where weighted are assigned to the various
items constituting the index
METHODS OF CONSTRUCTING PRICE INDEX NUMBERS

SIMPLE
AGGREGATIVE

UNWEIGHTED SIMPLE
AVERAGE OF
PRICE RELATIVE

INDEX NUMBERS

WEIGHTED
AGGREGATED
WEIGHTED

WEIGHTED
AVERAGE OF
PRICE RELATIVES
QUANTITY INDEX NUMBER
CHAIN BASE INDEX NUMBERS

One in which the figures for each are first

expressed as percentage of the
preceding year.The percentage are
chained together by successive
multiplication to form a series of chain
index, in chain base year index method
the base year changes from year to year.
ADVANTAGES OF CHAIN BASE INDEX
NUMBERS

The chain base index numbers facilitate

the introduction of new items as also the
deletion of absolute items in a smooth
manner
In business, often comparisons are made
in the current period with the immediately
preceding period rather than any distant
period in the past
LIMITATIONS OF CHAIN BASE INDEX
NUMBERS

If the data for any one year are not

available, the chain index number for
subsequent period cannot be computed.
If an error in the computation of any link
relative takes place , then such an error
gets compounded and the entire series
gives a distorted picture.
DEFLATING TIME SERIES USING INDEX
NUMBERS
Sometimes a price index is used to
measure the real values in economic time
series data expressed in monetary units.
For example, GNP initially is calculated in current
price so that the effect of price changes over a
period of time gets reflected in the data
collected. Thereafter, to determine how much
the physical goods and services have grown
over time, the effect of changes in price over
different values of GNP is excluded. The real
economic growth in terms of constant prices of
the base year therefore is determined by
deflating GNP values using price index.
SHIFTING AND SPLICING OF INDEX NUMBERS
These refer to two technical points: (a)
how the base period of the index may be
shifted, (b) how two index covering
different bases may be combined into
single series by splicing
Splicing
the process when two or more
overlapping series of index
numbers are combined into one
series
CAUTION IN USING INDEX NUMBERS

If the index numbers are defective on account

of one or more reasons, their interpretation will
lead to drawing of wrong inferences from them .
Even if index numbers are constructed on sound
statistical principles, but we interpret them in the
wrong manner, our conclusions will be wrong
 LIMITATIONS OF INDEX NUMBERS

Index numbers are based on sample data. In cased

sample size is extremely limited and its selection is
faulty in the sense that the sample units have not
been selected randomly, index numbers will give
wrong figures.
At times, index numbers can be manipulated by
those who are in authority. This is purposely done to
support their viewpoint.
A number of formulae can be used in index number
construction. These will give different results.