Business statistics UNIT -5

BBA III SEMESTER (NEP)

INDEX NUMBERS

INTRODUCTION:

Index numbers are devices which measure the change in the level of a phenomenon with respect to time,
geographical location or some other characteristic. The first index number was constructed in the year
1764 by an Italian named Carli to compare the changes in the price for the year 1750 with the price level
of the year 1500. In present day situation changes in production, consumption, exports, price level of the
year 1500. In present day situation changes in production, consumption, exports, imports, national
income, cost of living, incidence of crimes, number of road accidents, business failures and a very wide
variety of other phenomena are studied with the help of index numbers. Index numbers are supposed to be
barometers which measure the change in the level of a phenomena.

DEFINITION
“An index number is a statistical measure designed to show changes in variable or a group of related
variables with respect to time, geographical location or other characteristics.”-spiegal
An index number is a numerical expression showing relative percentage changes in the value of a
variable from one period to another.

CHARACTERISTICS OF INDEX NUMBERS/FEATURES

1. Index number are a specialized type of average: Averages can be used to compare only those series
which are expressed in the same units. However, the device of index number helps us in comparing change
in series which are in different units.
2. Index numbers study the effects of such factors which cannot be measured directly: Index numbers
are meant to study the changes in the effects of such factors which cannot be measured directly.
3. Index numbers being out the common characteristics of a group items.
4. Index number measure only relative changes in the values of a phenomenon.

ANURADHA.S
ISBR COLLEGE
Business statistics UNIT -5
BBA III SEMESTER (NEP)

USES OF INDEX NUMBER:

1. Help in Studying Trends: Index numbers helps to find out the trend of exports, imports, balance of
payments, industrial production, prices, national income and a variety of other phenomena.
2. Help in policy formulation: Index numbers help us in studying trends of various phenomena and these
trends and tendencies are the bases on which may policy decisions are taken index number are used by the
government in deciding the rates of D.A. and levy of excise duties.
3. Help in measuring the Purchasing Power of Money: Index numbers are helpful in finding out the
intrinsic worth of money as contrasted with its nominal worth.
4. Helps in deflating various value: Index numbers are very helpful in deflating national income on the
basis of constant prices.
5. Act as economic barometers: Index numbers measure the pulse of an economy and act as barometers
to find the ups and down in the general economic condition of a country.

PROBLEMS IN THE CONSTRUCTION OF INDEX NUMBERS

1. The selection of item- The first problem which the marker of an index number of wholesale prices has
to face is that of the selection of items from which the index number is to be constructed.
2. The selection of the base year- Second problem in the construction of index numbers is the selection of
the base year and the conversion of current prices to price relatives based on the prices of the base year.
3. The selection of the average- The next step in the construction of wholesale price index number is to
average the prices relatives of the various commodities
4. Selecting suitable weights- All the items used in the construction of an index number are not of equal
importance and as such if the index number is to be a representative one, weights should be assigned to
various items in relation to their importance.

ANURADHA.S
ISBR COLLEGE
Business statistics UNIT -5
BBA III SEMESTER (NEP)
METHODS OF CONSTRUCTING INDEX NUMBERS
Broadly speaking various methods of constructing index numbers can be classified in two groups viz.
A. Unweighted Index Numbers
B. Weighted Index Numbers
(i) Simple Aggregative Method
(ii) Simple Average of Relatives Method

NOTATION & TERMINOLOGY

p0: Price of a commodity in the base year

p1: Price of a commodity in the current year
q0: Quantity of a commodity consumed or purchased during base year
q1: Quantity of a commodity consumed or purchased in the current year
I = Price relative = P0/P1*100

TEST OF ADEQUACY/ CONSISTENCY

A perfect index number, which measures the change in the level of a phenomenon from one period to
another, should satisfy certain tests. There are FOUR major tests of index numbers: (1) Time reversal Test,
(2) Factor reversal Test, and (3) Circular Test (4) Unit Test

Time reversal Test: Fisher has pointed out that a formula for an index number should maintain time
consistency by working both forward and backward with respect to time. This is called time reversal test.
Fisher describes this test as follows
The test is that the formula for calculating an index number should be such that it gives the same ratio
between one point of comparison and the other, no matter which of the two is taken as base or putting in
another way the index number reckoned forward should be the reciprocal of that reckoned back ward”. A
good index number should satisfy the time reversal test.
This statement is expressed in the form of equation as P01 × P10 = 1.
Time reversal test is satisfied when P01 × P10 = 1 by Fisher’s Formulae.

ANURADHA.S
ISBR COLLEGE
Business statistics UNIT -5
BBA III SEMESTER (NEP)

Factor Reversal Test: This test is also suggested by Fisher According to the factor reversal test, the
product of price index and quantity index should be equal to the corresponding value index.

Fisher’s words “Just as each formula should permit the interchange of two times without giving
inconsistent results so it ought to permit interchanging the prices and quantities without giving inconsistent
results. i.e., the two results multiplied together should give the true ratio”

This requires the formula to be such that

Fisher’s formula does not satisfy this test. The simple aggregative method, G.M. of relatives method
formula satisfy this test
Fisher’s is the only formula which satisfies this test.
Circular Test: Circular test is an extension of the time reversal test. If three years 0, 1 and 2 are under
consideration, this requires the formula to be such that
P01 x P12 x P20 = 1
P01 is the index number of the second year in comparison with the first year, P12 is the index number of
the third year in comparison with the second and P2() is the index number of the first year in comparison
with the third.
Unit Test: This test requires the index numbers to be independent of the units in which prices and
quantities are quoted. This test is satisfied by all the formulae.

ANURADHA.S
ISBR COLLEGE
Business statistics UNIT -5
BBA III SEMESTER (NEP)
CONSUMER PRICE INDEX NUMBER / COST OF LIVING INDEX NUMBER

This is an index of changes in the prices of goods and services commonly consumed by a homogeneous
group of people, such as families of industrial workers. The major items of consumption that are
considered for the construction of CLI are:
1) Food
2) Fuel and Light
3) Clothing
4) House rent
5) Miscellaneous
Consumer Price Index number or Cost of living index number measures the effect of changes in the prices
of the described basket of goods and services on the purchasing power of a particular class of people
during current period as compared with some base period.

METHODS IN COMPUTATING CONSUMER PRICE INDEX NUMBER

i) Aggregate Expenditure Method or Weighted Aggregative Method: In the usual notations, the

It is the most popular method, and the formula is nothing but Laspeyre’s. On the basis of base year
quantities, total expenditures in current year and base year are calculated and the percentage of change is
worked out.
ii) Family Budget Method or Weighted Averages of Relatives Method.
The formula under this method as given in usual notations is

Weights (W) are determined on the basis of the family budget enquiry wherein the relative importance of
the items within a group and the relative importance of a group to the total are known. When W is base
year value (p0q0), both the methods become one and the same.

ANURADHA.S
ISBR COLLEGE
Business statistics UNIT -5
BBA III SEMESTER (NEP)

Uses:

1. Cost of living index numbers are the indicators of changes in real wages. Cost of living index numbers
help to know whether money wages overtake the rising prices or are overpowered by them.
2. Decisions on dearness allowance are based on the cost-of-living indices.
3. They are used for deflation of income and value in national accounts

ANURADHA.S
ISBR COLLEGE