INDEX NUMBERS

Index numbers are the indicators which reflect the relative changes in the level of a certain phenomenon
in any given period called the current period with respect to the values in some fixed period called the
based period selected for comparison. The phenomenon under consideration may be the prices of a
particular commodities like gold, silver, leather etc or group of commodities like cosmetics, consumer
goods, milk products, spices etc. volume of factory product, agricultural production, imports and exports,
shares sales, profits of a business etc, natural income of a country, wage structure in particular sector,
bank deposits, foreign exchange reserve, cost of living persons of particular class. Index numbers are
described as ECONOMIC BAROMETER.

DEFINITION

Index numbers are a series numbers by which changes in the magnitude of a phenomenon are measured
from time to time or place to place -- Horace secrist
Index numbers are devices for measuring differences in the magnitude of group of related variables. --
Croxton and Cowden
An Index Number is a single ratio which measures the combined change of several variables between the
two different times, places or situations.
Purpose:
The following are the different purposes for which the index numbers are computed:
1. To measure and compare changes in a variable or set of variables with some base year.
2. To measure the purchasing power of money which is of great help in finding out the real wages or
incomes of the people.
3. To provide guidelines to policy making in business field.

Uses of Index Numbers

1. Index numbers are called “Economic Barometers” as they indicate the pulses of economy and
tendencies in price fluctuations. They measure the pressure of economic activities of the country.
It helps in management personnel of any government organization or individual business concern
and in business planning and formulation of executive decisions. The indices of prices, output and
bank deposits, foreign exchange and reserves, etc., throw light on the nature of and variation in
general economic and business activity of the country. Index numbers are one of the widely used
statistical devices. They are used as to take the pulse of the economy and they have come to be
used as indicators of inflationary or deflationary tendencies.
2. Index numbers help in studying trends and tendencies. Since the index numbers study the relative
changes in the level of phenomenon at different periods of time. They are especially useful for the
study of general trend for a group phenomenon in a time series data.
3. Index numbers helps in formulating Decisions and policies. Index numbers of the data relating to
prices, production, profits, imports and exports, personnel and financial matters are indispensable
for any organization in efficient planning and formulation of executive decisions.
4. Price indices measure the purchasing power of money. The cost of living index numbers
determines whether the real wages are rising or falling, money wages remaining unchanged. They
help us in computing the real wages which are obtained on dividing the money wages by
corresponding price index and multiplied with 100.
 5. Index numbers are used for Deflation. Consumer price indices or cost of living index numbers are
used for deflation of net national product, income value series in national accounts.

Types of Index numbers:

Index numbers may be broadly classified into various categories depending upon the type of the
phenomenon or variable in which the relative changes are to be studied.

1.
2. Price index Number
3. Quantity Index Number
4. Value Index Number
5. Cost of living Index or Consumer Price
Index
6. Sensex
7. Index of Industrial production
8. Gross National Happiness
9. Prosperity Index
10. Human Poverty Index
11. Human Development Index
12. Corruption Perceptions Index
13. Global Competitive Index

Steps in Construction of Index Numbers:

1. The purpose of Index Numbers
2. Selection of commodities or items
3. Data for Index Numbers
4. Selection of Base year
5. Types of average to be used
6. System of weighting
7. Choice of formula

Notations and Terminology

Base year: the year selected for comparison is denoted by suffix zero’0’
Current Year: The year for which comparisons are sought or required and is denoted by suffix 1.
P0: price of the commodity in the base year
P1: price of the commodity in the current year
Q0: quantity of the commodity consumed or produced in the base year
Q1: quantity of the commodity consumed or produced in the current year
W: weight assigned to commodity according to its relative importance in the group.
P: Price relative
Q: Quantity relative
P01: Price index number for the current year w.r.t base year
P10: Price index number for the base year w.r.t current year
Q01: Quantity index number for the current year w.r.t base year
Q10: Quantity index number for the base year w.r.t current year
V01: Value index number for the current year w.r.t base year
V10: Price index number for the base year w.r.t current year

Methods of Constructing Index Numbers:

Index Numbers

Aggregate Average

Simple Simple
weighted weighted
(Unweighted) (Unweighted)
Cost of Living Index Number

Cost of living Index number is also termed as Consumer Price Index number are designed to measure the
effects of changes in the prices of a basket of goods and services on the purchasing power of a particular
section or class of the society during any given period w.r.t some fixed period. They reflect upon the
average increase in the cost of the commodities consumed by a class of people so that they can maintain
the same standard of living in the current year as in the base year. Cost of living index numbers are
constructed separately for different classes of people or groups or sections of the society and also for
different geographical areas like town, city, and rural area and so on.

Steps in construction of Cost of Living Index numbers

1. Scope and coverage
2. Class of people
3. Selection of base year
4. Family budget enquiry
5. Method of computation

Methods of construction of cost of living index numbers

1. Family Budget Method

2. Aggregate Expenditure Method

Uses of cost of living Index numbers

1. CPI are used to determine the purchasing power of money and for computing the real wages from
the nominal or money wages.
2. The government and many big industries and business units use the CPI to regulate the dearness
allowance or grant of bonus to the employees in order to compensate them for increased cost of
living due to price rise.
3. These are used for deflating income and value series in national accounts
4. These are used widely in wage negotiations and wage contracts.

Limitations of Index Numbers

1. Since index numbers are based on the sample data, they are only approximate indicators and may
not exactly represent the changes in the relative level of phenomenon
 2. There is likelihood error being introduced at each stage of construction of the index numbers
3. Due to dynamic pace of events and scientific advancements these days, there is a rapid change in
the taste, customs, fashions and consequently in the consumption patterns of the various
commodities among people in a society.
4. There is no formula which measures the price change or quantity change of a given body of a data
with exactitude or perfection.
5. By suitable choice of base year, commodities, price and quantity quotations index numbers are
liable to be manipulated by unscrupulous and selfish persons to obtain the desires results.

Problems:
1. Calculate the price index number using Fisher’s Ideal method:
Commodities 2002 2003
Price Qty. Price Qty.
A 21 15 20 17
B 70 10 75 12
C 60 14 62 15
D 32 10 30 10
E 36 12 38 8
2. From the following data calculate the price index number using:
a. Laspeyer’s, paasche’s, Dorbish-Bowley, Marshall-Edgeworth and Fisher’s method
b. Also show how it satisfies time reversal and factor reversal tests.
Commodities year 2015 year 2017
Value Qty. value Price
Wheat 320 40 500 50
Rice 675 75 1300 100
pulses 400 20 550 25
jowar 160 20 300 30
Gram 200 10 500 20
3. From the following data calculate the price index number using:
a. Laspeyer’s, paasche’s, Dorbish-Bowley, Marshall-Edgeworth and Fisher’s method
b. Also show how it satisfies time reversal and factor reversal tests.
Commodities Base year Current year
value Qty. value price
A 300 150 480 4
B 50 10 90 6
C 48 12 50 5
D 120 60 100 2
E 60 20 105 35
4. Calculate Fisher’s index number from the following information:
Commodities Base year Current year
Price Exp. Price Exp.
A 2 40 5 75
B 4 16 8 40
 C 1 10 2 24
D 5 25 10 60
5. The following are the group index numbers and group weights of an average family budget.
Construct consumer price index.
Group Index no. weights
Food 152 48
Fuel and lighting 110 6
Clothing 130 8
House rent 100 12
Misc. 90 15