Index Number

Index Number: Index Numbers are statistical devices design to measure the relative change in the level of
phenomenon with respect to time, geographical location or other characteristics such as income,
Profession etc.
Use of Index Number: Index numbers are indispensable tools of economic and business analysis. The
following points can best appreciate their significance.
1. They help in framing suitable policies: Many of the economic and business policies are guided by index
numbers. For example, for deciding the increase in dearness allowance (DA) of the employees, the
employer has to depend upon the cost of living index.
2. They reveal trends and tendencies: Since index numbers are most widely used for measuring changes
over a period of time, the time series so formed enable us to study the general trend of the phenomenon
under study.
3. Index Number are very useful in deflating: Index numbers are used to adjust the original data for price
changes, or adjust wage for cost of living changes and this transformed nominal wages into real wages.
4. Useful in asses exports and Imports.
 Index Number

Classification of Index Number: There are mainly there types of index Numbers:
Price index Number: Indicator of the real change in commodity price due to change in time is known as
Price Index Number. It is widely used in economics, trade and commerce.
Quantity Index Number: The indicator of relative changes in the commodity quantity due to change in
time is called quantity index number. The index number measures the relative change in the quantity of
production, Import, export or consumption.
Value Index Number: The indicator of the relative change in the commodity value (price × quantity) due
to change in time is called value index number.
Problems involved in the Construction of Index Numbers :
The purpose of index Number. Selection of commodities. Data for index number. Selection of
base period. Selection of average to be used Selection of appropriate weights Selection of
appropriate formula
Method of construction of Index Number:
A large number of formulae have been devised for constructing index numbers. They can be grouped under
two heads (1) Un-weighted Indices (2) Weighted Indices
 Index Number
A. Un-weighted indices: (1) Simple Aggregative Method (2) Simple Average of Price Relative Method
I. Simple Aggregative Method.
σ 𝑝1
𝑝01 = σ × 100
𝑝0
Where σ 𝑝1 =Total Current year Prices for various commodities And σ 𝑝0 =Total base year Prices for
various Commodities 𝑝01 =Price Index for Current year corresponding to base year.
II. Simple Average of Price Relatives Method
𝑝
σ 1 ×100
𝑝0
𝑝01 = where N= Number of items (commodities).
𝑁
B. weighted index Number:
I. Weighted Aggregative Method II. Weighted Average of Relatives Method
I. Weighted Aggregative Method: Different formulae for weighted Aggregative Method Laspeyre’s Price
Index or Base Year Method
σ 𝒑 𝟏 𝒒𝟎
Laspeyre’s Price Index or Base Year Method, 𝒑𝟎𝟏 = σ × 𝟏𝟎𝟎
𝒑 𝟎 𝒒𝟎
 Index Number
σ 𝒑𝟏 𝒒𝟏
Paasche’s Price Index or Current Year Method, 𝒑𝟎𝟏 = σ × 𝟏𝟎𝟎
𝒑𝟎 𝒒𝟏
σ 𝒑𝟏 𝒒𝟎 σ 𝒑𝟏 𝒒𝟏
+
σ 𝒑𝟎 𝒒𝟎 σ 𝒑𝟎 𝒒𝟏
Bowley’s method, 𝒑𝟎𝟏 = × 𝟏𝟎𝟎
𝟐
σ(𝒒𝟎 +𝒒𝟏 )𝒑𝟏
Marshall-Edgeworth method, 𝒑𝟎𝟏 = σ × 𝟏𝟎𝟎
(𝒒𝟎 +𝒒𝟏 )𝒑𝟎

σ 𝒑𝟏 𝒒𝟎 σ 𝒑𝟏 𝒒𝟏
Fisher’s ideal method, 𝒑𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
×σ × 𝟏𝟎𝟎
𝒑𝟎 𝒒𝟏

TESTS OF INDEX NUMBER Several formulae has been suggested for constructing index numbers and the
problem is that of selecting the most appropriate one in a given situation. The following tests are suggested for
choosing an appropriate index.
(1) Time Reversal Test (2) Factor Reversal test (3) Circular Test
1.Time Reversal Test : Time reversal test is a test to determine whether a given method will work both ways in
time, forward and backward. Symbolically, the following relation should be satisfied 𝑝01 × 𝑝10 = 1 Fishers
ideal formula and Marshall-Edgeworth formula satisfy the time reversal test
 Index Number
2. Factor Reversal Test: According to this test the product of quantity index number and the price index number
σ𝑝 𝑞
will be equal to the value index numbers; 𝑝01 × 𝑄01 = 𝑉01 = σ 𝑝1𝑞1
0 0

The factor reversal test is satisfied only by the Fishers ideal index.
Show that Time Reversal Test and The factor reversal test are satisfied by the Fishers ideal Method
Proof: When Fisher’s ideal method is used for time reversal test
σ 𝒑𝟏 𝒒𝟎 σ 𝒑𝟏 𝒒𝟏 σ 𝒑𝟎 𝒒𝟏 σ 𝒑𝟎 𝒒𝟎
𝒑𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
×σ and 𝒑𝟏𝟎 = σ 𝒑𝟏 𝒒𝟏
×σ
𝒑𝟎 𝒒𝟏 𝒑𝟏 𝒒𝟎

σ 𝒑𝟏 𝒒𝟎 σ𝒑 𝒒 σ𝒑 𝒒 σ𝒑 𝒒
∴ 𝑝01 × 𝑝10 = σ 𝒑𝟎 𝒒𝟎
× σ 𝒑𝟏 𝒒𝟏 × σ 𝒑𝟎 𝒒𝟏 × σ 𝒑𝟎 𝒒𝟎 = 𝟏
𝟎 𝟏 𝟏 𝟏 𝟏 𝟎

Since 𝑝01 × 𝑝10 = 1, the Fisher’s ideal method is satisfied.

When Fisher’s ideal method is used for factor reversal test
σ 𝒑𝟏 𝒒𝟎 σ𝒑 𝒒 σ 𝒒𝟏 𝒑𝟎 σ𝒒 𝒑
𝒑𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
× σ 𝒑𝟏 𝒒𝟏 and 𝑸𝟎𝟏 = σ 𝒒𝟎 𝒑𝟎
× σ 𝒒𝟏 𝒑𝟏
𝟎 𝟏 𝟎 𝟏

σ 𝒑𝟏 𝒒𝟎 σ𝒑 𝒒 σ𝒒 𝒑 σ𝒒 𝒑 σ𝑝 𝑞
𝒑𝟎𝟏 × 𝑸𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
× σ 𝒑𝟏 𝒒𝟏 × σ 𝒒𝟏 𝒑𝟎 × σ 𝒒𝟏 𝒑𝟏 = σ 𝑝1 𝑞1 = 𝑉01
𝟎 𝟏 𝟎 𝟎 𝟎 𝟏 0 0
σ𝑝 𝑞
Since 𝑝01 × 𝑄01 = 𝑉01 = σ 𝑝1 𝑞1 , The factor reversal test is satisfied by the Fishers ideal Method
0 0
 Index Number
Construct index numbers of price from the following data by applying 1. Laspeyre’s method 2. Paasche’s
method 2. Bowley’s method 3. Marshall-Edgeworth method 4. Fisher’s ideal method
Commodity 2010 2011
Price Quantity Price Quantity
A 2 8 4 6
B 5 10 6 5
C 4 14 5 10
D 2 19 2 13
Solution: Calculation of various indices:
Commodity 2010 2011 𝑝1 𝑞0 𝑝0 𝑞0 𝑝1 𝑞1 𝑝0 𝑞1
Price (𝑝0 ) Quantity(𝑞0 ) Price(𝑝1 ) Quantity(𝑞1 )
A 2 8 4 6 32 16 24 12
B 5 10 6 5 60 50 30 25
C 4 14 5 10 70 56 50 40
D 2 19 2 13 38 38 26 26
෍ 𝑝1 𝑞0 ෍ 𝑝0 𝑞0 ෍ 𝑝1 𝑞1 ෍ 𝑝0 𝑞1

= 200 = 160 = 130 = 103

 Index Number
σ𝒑 𝒒 𝟐𝟎𝟎
Laspeyre’s Method, 𝒑𝟎𝟏 = σ 𝒑𝟏 𝒒𝟎 × 𝟏𝟎𝟎 = 𝟏𝟔𝟎 × 𝟏𝟎𝟎 = 𝟏𝟐𝟓
𝟎 𝟎

σ𝒑 𝒒 𝟏𝟑𝟎
Paasche’s Method, 𝒑𝟎𝟏 = σ 𝒑𝟏 𝒒𝟏 × 𝟏𝟎𝟎 = 𝟏𝟎𝟑 × 𝟏𝟎𝟎 = 𝟏𝟐𝟔. 𝟐𝟏
𝟎 𝟏
σ 𝒑𝟏 𝒒𝟎 σ 𝒑𝟏 𝒒𝟏 𝟐𝟎𝟎 𝟏𝟑𝟎
+
σ 𝒑𝟎 𝒒𝟎 σ 𝒑𝟎 𝒒𝟏 +
Bowley’s method, 𝒑𝟎𝟏 = × 𝟏𝟎𝟎 = 𝟏𝟔𝟎 𝟏𝟎𝟑
× 𝟏𝟎𝟎 = 𝟏𝟐𝟓. 𝟔𝟏
𝟐 𝟐
σ(𝒒 +𝒒 )𝒑 𝟐𝟎𝟎+𝟏𝟑𝟎
Marshall-Edgeworth method, 𝒑𝟎𝟏 = σ(𝒒𝟎 +𝒒𝟏)𝒑𝟏 × 𝟏𝟎𝟎 = 𝟏𝟔𝟎+𝟏𝟎𝟑 × 𝟏𝟎𝟎 = 𝟏𝟐𝟓. 𝟒𝟖
𝟎 𝟏 𝟎

σ 𝒑𝟏 𝒒𝟎 σ𝒑 𝒒 𝟐𝟎𝟎 𝟏𝟑𝟎
Fisher’s ideal method, 𝒑𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
× σ 𝒑𝟏 𝒒𝟏 × 𝟏𝟎𝟎 = × × 𝟏𝟎𝟎 = 𝟏
𝟎 𝟏 𝟏𝟔𝟎 𝟏𝟎𝟑

❑ Show with the help of the following data that the Time Reversal Test and Factor Reversal Test
are satisfied by Fisher’s Ideal method for index number construction:
Commodity Base year Base year Current Year Current Year

Price(tk) Quantity(kg) Price(tk) Quantity(kg)

A 6 8 4 6
B 2 10 6 5
C 4 14 5 10
D 8.5 19 2 13
E 8
 Index Number
Solution: Computations for Time Reversal Test and Factor Reversal Test:
Commodity Base year Base year Current Year Current Year 𝑝1 𝑞0 𝑝0 𝑞0 𝑝1 𝑞1 𝑝0 𝑞1

Price(𝑝0 ) Quantity(𝑞0 ) Price(𝑝1 ) Quantity(𝑞1 )

A 6 50 10 56 500 300 560 366
B 2 100 2 120 200 200 240 240
C 4 60 6 61 360 240 366 244
D 8.5 30 12 24 360 255 288 204
E 8 40 16 22 640 320 352 175

෍ 𝐩 𝟏 𝐪𝟎 ෍ 𝒑 𝟎 𝒒𝟎 ෍ 𝐩 𝟏 𝐪𝟏 ෍ 𝒑 𝟎 𝒒𝟏

= 𝟐𝟎𝟔𝟎 = 𝟏𝟑𝟑𝟓 = 𝟏𝟖𝟎𝟔 = 𝟏𝟐𝟎𝟎

Time Reversal Test is satisfied when 𝑝01 × 𝑝10 = 1

σ 𝒑𝟏 𝒒𝟎 σ𝒑 𝒒 σ 𝒑𝟎 𝒒𝟏 σ𝒑 𝒒
We have 𝒑𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
× σ 𝒑𝟏 𝒒𝟏 and 𝒑𝟏𝟎 = σ 𝒑𝟏 𝒒𝟏
× σ 𝒑𝟎 𝒒𝟎
𝟎 𝟏 𝟏 𝟎

σ 𝒑𝟏 𝒒𝟎 σ𝒑 𝒒 σ𝒑 𝒒 σ𝒑 𝒒 𝟐𝟎𝟔𝟎 𝟏𝟖𝟎𝟔 𝟏𝟐𝟎𝟎 𝟏𝟑𝟑𝟓

so, 𝑝01 × 𝑝10 = σ 𝒑𝟎 𝒒𝟎
× σ 𝒑𝟏 𝒒𝟏 × σ 𝒑𝟎 𝒒𝟏 × σ 𝒑𝟎 𝒒𝟎 = × × × =1
𝟎 𝟏 𝟏 𝟏 𝟏 𝟎 𝟏𝟑𝟑𝟓 𝟏𝟐𝟎𝟎 𝟏𝟖𝟎𝟔 𝟐𝟎𝟔𝟎

Hence Time Reversal Test is satisfied.

 Index Number
σ 𝑝1 𝑞1
Factor Reversal Test is satisfied when 𝑝01 × 𝑄01 = σ
𝑝0 𝑞0

σ 𝒑𝟏 𝒒𝟎 σ 𝒑𝟏 𝒒𝟏 σ 𝒒𝟏 𝒑𝟎 σ 𝒒𝟏 𝒑𝟏
We have, 𝒑𝟎𝟏 = σ 𝒑𝟎 𝒒𝟎
×σ and 𝑸𝟎𝟏 = σ 𝒒𝟎 𝒑𝟎
×σ
𝒑𝟎 𝒒𝟏 𝒒𝟎 𝒑𝟏

σ 𝒑𝟏 𝒒𝟎 σ 𝒑𝟏 𝒒𝟏 σ 𝒒𝟏 𝒑𝟎 σ 𝒒𝟏 𝒑𝟏 𝟐𝟎𝟔𝟎 𝟏𝟖𝟎𝟔 𝟏𝟐𝟎𝟎 𝟏𝟖𝟎𝟔 𝟏𝟖𝟎𝟔

𝒑𝟎𝟏 × 𝑸𝟎𝟏 = σ × σ 𝒑𝟎 𝒒𝟏
× σ 𝒒𝟎 𝒑𝟎
×σ = × × × = which is also
𝒑𝟎 𝒒𝟎 𝒒𝟎 𝒑𝟏 𝟏𝟑𝟏𝟓 𝟏𝟐𝟎𝟎 𝟐𝟎𝟔𝟎 𝟐𝟎𝟔𝟎 𝟐𝟎𝟔𝟎
σ𝑝 𝑞
the value of σ 1 1 .
𝑝0 𝑞0

Hence Fisher’s Ideal Index satisfies the Factor Reversal Test.

 Homework
❑ Calculate Index number by using Fisher’s ideal method and also set Time Reversal Test and Factor
Reversal Test :
Commodity 2010 2011
Price Quantity Price Quantity
A 50 15 45 16
B 55 10 52 12
C 42 20 38 25
D 48 16 40 20
E 60 8 50 10

❑ From the following data construct on index number for 2015 taking 2014 as the base year using simple
aggregate method:
Commodity and Units Butter(kg) Cheese(kg) Milk(lt) Bread(I) Eggs (doz.) Ghee(1 tin)
Price in 2014 (taka) 110 75 13 9 18 850
Price in 2015 (taka) 120 13 13 9 20 860

σ 𝒑𝟏 𝒒𝟎
Hints: Formula 𝒑𝟎𝟏 = σ × 𝟏𝟎𝟎
𝒑𝟎 𝒒𝟎

❑ Why is Fisher’s ideal method ideal ?