INDEX NUMBERS

AN INTRODUCTION
What is an Index Number ?: An index number is the measure of change in a variable (or a
group of variables) over time.

What do they represent?: They represent general, relative changes. They are typically
expressed as percentage (% ).

Where are they used? : Typically used in economics to measure trends in stock market
prices, industrial or agricultural production and imports. They are one of the most used
statistical tools in economics.
 USES OF INDEX NUMBERS
Economic Barometers
Used by the govt and biz. to measure
the pulse of economic activities
Providing a Value for
Comparison
Comparing magnitudes of aggregates
of related variables to each other, and
to measure their changes over time.
Measuring Changes
in the standard and cost of living
as well as the price level
Information regarding
Foreign Trade
EXIM Policies are formed using
export-import indices which give
relative information
Government Policies
Are framed following different price
indices, also involving monetary and
fiscal policies
A Tool for the Business
Community
Price Indices are a very useful guide
to the business community in planning
and decision making
 DIFFERENT INDEX NUMBERS USED
Price Index Numbers
They measure the relative changes in
prices of a commodity between two
periods
Industrial Index
Numbers
They are constructed for measuring
changes in the industrial production
by using industrial prodn. data
Quantity Index Numbers
They measure changes in the physical
quantity of goods produced, consumed or
sold of an item or a group of items.
Wage Index Numbers
They measure the time to time
changes in money wages.They provide
information regarding the changes in
the real wages of the workers.
Cost of Living Index
Numbers
They are constructed with reference to the
important goods and services which are
consumed by common people.
Stock Market Index
Numbers
It is an index that measures a stock
market, or a subset of the stock
market,
 WAYS TO CONSTRUCT INDEX NUMBERS
SIMPLE 01 02
METHOD Simple Aggregate Method
Simple Average of Price
Relatives Method

WEIGHTED 03 04
METHOD Weighted Aggregate Weighted Average of Price
Method Relatives Method
 SIMPLE
(Un-Weighted)
METHOD
 SIMPLE AGGREGATE
METHOD
METHOD: The index numbers is calculated by dividing the sum of the current year prices 𝝨p1 , by the sum of the base year prices
𝝨p0. MERITS and DEMERITS

FORMULA: P01 = 𝝨p1 x 100 ; Q01 = 𝝨 q1 x 100 This method is the simplest method for constructing index
numbers, but lacks accuracy as it considers only one aspect
𝝨p0 𝝨 q0 (price or quantity ) at a time.

Easy to understand and quick to compute but the relative

importance of items is not considered.
 SIMPLE AGGREGATE METHOD (contd.)
EXAMPLE:: Find out the price index number from the following data.

Commodity A B C D E Total
1993 (BaseYr.) 50 40 10 5 2 𝝨Po = 107
1994 (Cur. Yr.) 80 60 20 10 6 𝝨P1= 176

P01 = Σp1 x 100 PRACTICE QUESTION: (Hint: Take the Base Year as the older year) Ans. 104
Σp0 Commodity A B C

1995 4 60 36
= 176 x 100 = 164.48
107 2005 5 57 42
SIMPLE AVG. OF PRICE
RELATIVE METHOD
METHOD: This method is based on the average relative price of the commodities. A price relative is a ratio between the current year
price and the base year price of a commodity expressed in percentage.
MERITS and DEMERITS

FORMULA: Price Relative(P) = Current Yr. Price(P1) x 100 The extreme values will not affect the index but the
Base Yr. Price (P0) selection of average is not clear.

Price Index based on Simple average of price relatives: Equal importance will be given to all items but the relative
Price Index (P01 ) = 𝝨P x 100 importance of commodities are neglected.

N (No. of Commodities)
 SIMPLE AVERAGE OF PRICE RELATIVE METHOD (contd.)
EXAMPLE:: Find out the price index number using Price Relative Method from the following data.
Commodity Rice Wheat Fish Potato Coal Total
BaseYr.Price 50 40 10 5 2 𝝨Po = 107
Curr. Yr.Price 80 60 20 10 6 𝝨P1= 176
Price Relative 116.67 113.64 118.64 125 120 𝝨(P0/ P1) x100
P=P0 / P1) x 100) = 593.83

P01 = 𝝨 P = 593.83 = 118.77

N 5
 SIMPLE AVERAGE OF PRICE RELATIVE METHOD (contd.)
PRACTICE QUESTION:: Find out the price index number using Price Relative Method from the following data.

Commodity Cotton Wheat Rice Grams

1990(BaseYr.) 909 288 767 659
1991(Curr.Yr.) 874 305 910 573

Answer: 79.54 (Base Year as the older year)

WEIGHTED
METHOD
 LASPEYRE’S METHOD
WHAT IS IT? This formula was devised by French economist Laspeyer in 1871. Laspeyre's Price Index is a weighted aggregate index based on
BASE YEAR QUANTITIES (q0) of respective commodities.

METHOD: The Laspeyre’s Index is calculated by working out the cost of a group of commodities at current prices , dividing this by the cost of
the same group of commodities at base period prices, and then multiplying by 100. This means that the base period index number is always 100.

FORMULA: PL = Σp1q0 x 100 ;where i) p0 is the price/item in the base year ii) p1 ia the price/item in the curr. yr.
Σp0q0 iii) q0 is the qty. of individual item in the base year
 LASPEYRE’S METHOD (contd.)
EXAMPLE:: Compute Laspeyre’s Index Number from the following data
Commodity 1995 2000 Computations for the Problem
Price(p0) Quantity(q0) Price(p1) Quantity(q1) p1q0 p0q0
A 6 50 10 56 500 300
B 2 100 2 120 200 200
C 4 60 6 60 360 240
D 10 30 12 24 360 300
E 8 40 12 36 480 320
Total 1900 1360
 LASPEYRE’S METHOD (contd.)
Laspeyre’s Index Number is: PRACTICE QUESTION: Compute the Laspeyre’s Index No. from the data.
PL = 𝚺p1q0 x 100 (Ans. 109.93)
𝚺p0q0 Item 2004 2017
= 1900 x 100
Price Quantity Price Quantity
1360
= 139.71 A 8 13 10 9

A SMALL TRICK TO REMEMBER: B 10 6 11 6

C 5 20 5 20
Ensure that only q0 is there in the
num. and den. and always use the D 3 10 2 12
values of the current year prices on
the numerator. E 2 4 4 5
 PAASCHE”S METHOD
WHAT IS IT? This formula was devised by German statistician Paasche’s in the mid 19th Century. Paasche's Price Index is a weighted
aggregate index based on CURRENT YEAR QUANTITIES (q1) of respective commodities.

METHOD: To get “p0q1” you have to multiply the base year price with current year quantity and sum it up to get 𝚺p0q1. Similarly to get
t “p1q1” multiply current year price with current year quantity of the commodities and sum it up the column to get 𝚺p1q1.

FORMULA: PP = Σp1q1 x 100 ;where i) p0 is the price per item in the base year ii) p1 ia the price per item in the curr.
Σp0q1 iii) q1 is the qty. of individual item in the current year
 PAASCHE’S METHOD (contd.)
EXAMPLE:: Compute Paasche’s Index Number from the following data (Same values as the prev. sum)
Commodity 1995 2000 Computations for the Problem
Price(p0) Quantity(q0) Price(p1) Quantity(q1) p1q1 p0q1
A 6 50 10 56 560 336

B 2 100 2 120 240 240

C 4 60 6 60 360 240

D 10 30 12 24 288 240

E 8 40 12 36 432 288

Total 1880 1344

 PAASCHE’S METHOD (contd.)
Therefore Paasche’s Index Number is: PRACTICE QUESTION: Compute the Laspeyre’s Index No. from the data.
PP = 𝚺p1q1 x 100 (Ans. 252.25)
𝚺p0q0
Item Base Year Current Year
= 1880 x 100
1344 Price Quantity Price Quantity
= 139.80
A 2 10 5 11

A SMALL TRICK TO REMEMBER: B 5 6 8 9

C 4 5 12 10
Replace ‘q0’ from Laspeyre’s
Formula with ‘q1’ to get Paasche’s D 3 16 9 16
Formula.
FISHER’S METHOD and THE
TIME REVERSAL CONCEPT
FISHER”S REQUISITE FOR THE CONSTRUCTION OF AN INDEX NO.:Prof. Irving Fisher. mentioned that “The formula for
calculating an index number should be such that even if the base periods are interchanged the two index numbers should be reciprocal to each other.”

TIME REVERSAL CONCEPT: The Time Reversal Test demands that P01 x P10 = 1 ; where P10 represents the given
index number for time 1 on 0 and P01 represents the index number from time 0 on 1.

WHY IS FISHER’S METHOD CONSIDERED AS THE IDEAL WAY OF INDEX NUMBER CONSTRUCTION?
It is to be noted that while both Laspeyres’ method and Paasche’s method do not satisfy the Time Reversal Test as it considers only one time frame
aspect (either the base year or the current year qty)
FISHER’S METHOD and THE TIME
REVERSAL CONCEPT(Contd.)
F
FORMULA: P
01
= Σp1q0 x Σp1q1 or Laspeyre’s Formula x Paasche’s Formula
Σp0q0 Σp0q1

PROOF THAT FISHER’S INDEX NUMBER SATISFIES THE TIME REVERSAL TEST:
F
P
01
= Σp1q0 x Σp1q1 ; and P10F = Σp0q1 x Σp0q0
Σp0q0 Σp0q1 Σp1q1 Σp1q0

Time Rev. Concept: P01F x P10F= Σp1q0 x Σp1q1 x Σp0q1 x Σp0q0 = 1

(Should be = 1) Σp0q0 Σp0q1 Σp1q1 Σp1q0
FISHER’S METHOD and THE TIME
REVERSAL CONCEPT (Contd.)
EXAMPLE: Compute the Fisher’s Index Number. (Fig. from the previous methods’ problems are used for better understanding)
Item 1995 2000 Components of Laspeyre’s Method Components of Paasche’s Method

Price(p0) Qty. (q0) Price(p1) Qty,(q1) p1q0 p0q0 p1q1 p0q1

A 6 50 10 56 500 300 560 336

B 2 100 2 120 200 200 240 240

C 4 60 6 60 360 240 360 240

D 10 30 12 24 360 300 288 240

E 8 40 12 36 480 320 432 288

Total 1900 1360 1880 1344

FISHER’S METHOD and THE TIME
REVERSAL CONCEPT(Contd.)
F
FORMULA: P
01
= Σp1q0 x Σp1q1 or Laspeyre’s Formula x Paasche’s Formula
Σp0q0 Σp0q1

= 1900 x 1800 = 1.87 = 1.367

1360 1344

SMALL TRICKS TO REMEMBER:

● To interchange the base year with the current year replace 0 with 1 and 1 with 0 and maintain the ‘p’ and ‘q’ in their original places
in the formula.
● Fisher’s formula is just a combination of Laspeyre’s and Paasche's Formula.
FISHER’S METHOD and THE TIME
REVERSAL CONCEPT (Contd.)
PRACTICE PROBLEM: Compute the Fisher’s Index Number and check if it satisfies the Time Reversal test.
(Ans. 0.986 and Time Reversal is satisfied)
Item 2018 2019

Price(p0) Qty. (q0) Price(p1) Qty,(q1)

A 8 5 10 6

B 10 6 12 4

C 5 4 5 5

D 14 7 13 11.5

E 20 2.5 25 3
FISHER’S METHOD and THE FACTOR
REVERSAL CONCEPT
WHAT IS IT? Factor Reversal Test (FRT) is another test proposed by Prof. Irving Fisher which says that his formula holds even when we
interchange two times it should hold even when the price and quantity are changed. .
F F
Factor Reversal Test demands, P x Q = Σp1q1
01 01
Σp0q0
F
P
01
= Σp1q0 x Σp1q1 ; Q01F = Σq1p0 x Σq1p1
Σp0q0 Σp0q1 Σq0p0 Σq0p1

Factor Reversal Test: P01F x Q01F = Σp1q0 x Σp1q1 x Σq1p0 x Σq1p1 = Σp1q1
Σp0q0 Σp0q1 Σq0p0 Σq0p1 Σp0q0
FISHER’S METHOD and THE FACTOR
REVERSAL CONCEPT
EXAMPLE: Using the same figures from Slide 21 check if the Factor Reversal Test is compatible with Fisher’s Index Number.

Factor Reversal Test: P01F x Q01F = Σp1q0 x Σp1q1 x Σq1p0 x Σq1p1 = Σp1q1
Σp0q0 Σp0q1 Σq0p0 Σq0p1 Σp0q0

LHS = 1900 x 1880 x 1344 x 1880 = 1880 = RHS

SMALL TRICK TO
REMEMBER: 1360 1344 1360 1900 1360
In order to get Q01F get just
replace P with Q and vice
versa in P01F Hence Factor Reversal Test is Satisfied
CONSUMER
PRICE
INDEX
 AN INTRODUCTION TO CPI
WHAT IS IT? Consumer price index is the index number of the cost met by a specified class of consumers in buying a Basket of
goods and services' . Here Basket of goods and services' means goods and services needed in day-to-day life of the specified class of
consumers.
WHY IS IT CONSTRUCTED? The necessity of the construction of cost of living index arises on account of the fact that wholesale price
index numbers measure the variations only in the general level of prices. In order to measure the effects of variations in the prices of
various commodities on the cost of living of different classes of people, separate index numbers are constructed for different groups.

SOME UTILITIES OF THIS INDEX: i) Used to determine the purchasing power of money and for computing the real
wages.ii) commonly used in fixation of salary, dearness allowance to the employees iii) comparing changes in the
cost of living of different classes of people. iv) used for deflating money or income v) used by the government
(central/state) for the formulation of price policy, wage policy and general economic policies.
 METHOD OF CPI CONSTRUCTION
Main steps involved in the construction of consumer price index numbers:
1. Defining purpose and scope
The purpose of index number must be clearly defined. It is very vital to decide the class of people for whom the index number is to be
constructed along with the geographical area.
2. Conducting family budget enquiry and selecting the weights:
The objective of the enquiry is to find out the expenses which a family spends on different items of consumption.Here, the enquiry is
conducted on a random basis, during a period of economic stability, thus giving us the average budget of that class.
3. Obtaining price quotations:
While constructing cost of living index number, retail prices of different commodities are to be collected. price quotations should be obtained
from different localities and averaged. These averages are made use in the construction of index numbers
4. Computing the index numbers:
There are two methods of computing CPI. They are discussed in detail in the further slides They are:
a. Aggregative expenditure method. b. Family budget method.
METHODS TO CONSTRUCT A CONSUMER PRICE INDEX
AGGREGATE EXPENDITURE
METHOD
CPI = Σp1q0 x 100 (Laspeyre’s No.)
Σp0q0
In this method, the base year quantities la)
for various commodities consumed by a
particular class of people are taken as
weights. Consumer price index by aggregative
expenditure method is similar to Laspeyre’s
Index Nos. formula
FAMILY BUDGET
METHOD
CPI = ΣRW ; where R is the Price Relative and W is p0q0
ΣW
In this method, CPI is constructed by using
weighted arithmetic mean of price relatives
(R) , the weights (W) being the values of the
items consumed in the base year.
Here weight, w = p
 AGGREGATE EXPENDITURE METHOD
METHOD: In this method, the quantities of commodities consumed by the particular group in the BASE YEAR are estimated and these
figures or their proportions are used as weights. The price of the current year is multiplied by the quantity or weight of the base year. These
products are added. In this method, the current period quantities are not used as weights because these quantities change from year to
year. This method is very similar to the Laspeyre’s method of Index Number Construction.

FORMULA: CPI01= ∑P1Q0 x 100

∑P0Q0
Where,
P1 represents the price of the current year.
P0 represents the price of the base year.
Q0 represents the quantity consumed in base year.
 AGGREGATE EXPENDITURE METHOD
EXAMPLE: Compute the CPI using the Aggregate Expenditure Method
Item Qty in 2016 (Q0) Price in 2016(P0) Price in 2021(P1) P0Q0 P1Q0

A 40 10 15 400 600

B 20 25 40 500 800

C 10 15 20 150 200

D 30 20 30 600 900

E 60 30 50 1800 3000

Total 5500 3450

Consumer price index= ∑P1Q0 *100 = 3450 *100 = 62.72

∑P0Q0 5500
 FAMILY BUDGET METHOD
METHOD: In this method, CPI is constructed by using weighted arithmetic mean of price relatives, the weights being the values of the
items consumed in the base year. The CPI calculated from bote the methods are identical.

FORMULA: CPI01= ∑PW

∑W
Where,
P is the Price Relative whose formula is discussed in (p1/p0 x 100) Simple Average Price Relative Method (Slide 10)
W is the total cost of goods and services in the base year ( p0q0)
 FAMILY BUDGET METHOD (Contd.)
EXAMPLE: Compute the CPI using the Family Budget Method.
Item 2000 2021 P= p1/p0 x 100 W= P0Q0 WP

Price (p0) QtQty.(q0) Price(p1)

A 200 30 220 110 6000 660000

B 60 10 60 100 600 60000

C 50 25 40 80 1250 100000

D 20 30 20 100 600 60000

E 70 34 70 100 280 28000

Total 8730 908000

CPI01= ∑PW = 908000 = 104.009

∑W 8730
THANK YOU !!!
 TEAM MEMBERS AND CONTRIBUTIONS
Register No. Name Contribution
2010320 Shrivatsav Baskar PPT Compilation and Presentation

2010315 Raunak Jalan Meaning and Uses of Index Numbers

2010316 Sabrish M Different Index numbers Used

2010358 Annapoorna K Simple Aggregate and Simple Average of Price Relatives Method

Sankalpa Laspeyre’s Method

2010389 Arul Skanda Paasche’s Method

2010330 Mehaak Fisher’s Method and the Time Reversal Concept

2010341 Ansh Goel Factor Reversal Concept

Mohini CPI and the Family Budget Method

2010381 Himalesh Aggregate Expenditure Method