INDEX NUMBERS

Index number is a statistical measurement and is counted as a barometer of economic activity, because it measures the up and down with respect to time or space occurs in the prices/quantities of a commodity or a group of different commodities. Index number is a device which measures the level of a certain phenomenon at any given period in comparison with the level of the same phenomenon at some standard period, called the base period. Or index number is a statistical quantity that measures an average change in the prices/quantities of commodities with respect to time or space. For example, cost of education for a student at different institutions, wages of workers, Pakistan exports and imports etc.
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The time may be an hour, day, month, quarter or year. The time is generally called period. Where as the space means, the change of place, for example, comparison of wheat prices in Peshawar with that in Lahore city. So Peshawar and Lahore are two different places (spaces). Index number is broadly categorized into simple and composite index numbers.

Index Numbers

Simple Index Number

Composite Index Number

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SIMPLE AND COMPOSITE INDEX NUMBERS

An index number computed for a single commodity, is called simple index number. For example, index number of wheat prices, index number of Shama Ghee and index number of cotton export etc. Here, in all the examples only one commodity has been taken into account, so the index number computed is labeled as simple index number. An index number computed for two or more than two commodities, is called composite index number. For example, index number of Pakistan exports (Pakistan exports different commodities i.e. more than one commodity at each period), index number of industrial production, consumer price index numbers and whole sale price index numbers etc. Composite indexes are more generally used as compare to simple index number because many of the index numbers are composite in nature.
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Composite Index Numbers

Unweighted Index Number

Weighted Index Number

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FIXED BASE AND CHAIN BASE METHODS

Fixed Base Method: If a series of prices or quantities for a number of years is given, then calculation of index number for each year with regard to a fixed year is called the construction of index number by fixed base method. In this method the prices or quantities of a particular period/year is used as a base, the base period should not too far distant in the past and should be a normal period, i.e. a period which is free from financial crisis and has economic stability. But according to Croxton and Cowden, it is not possible, that no one period is perfectly normal to be a good base for comparison, because Prices are always advancing or receding with the business cycle. Thus, in case of unavailability of suitable base period, the averages of prices of several periods/years are taken as the base. This average minimizes the influence of abnormal and disrupted economic conditions.
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FIXED BASE METHOD-continued

To compute index number by fix base method, the value of the base period is taken as 100. The index numbers for other periods/years are computed by dividing the price of a given year by the price of a base year, the values so obtained are called price relatives. These price relatives are then expressed as a percentage. In case of composite index number, an average of the percentage price relatives gives the index for the given period. The price relative is a pure number i.e. it is independent of any unit of measurement.

Price of the given period commodity 100 Pon = Price of the base period commodity P Pon = n 100 P0
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Example: The following show the price (Rs.) of 15 bags of wheat for the years 1980-1990.
Year Price 1980 6983 1981 7222 1982 7393 1983 7343 1984 7258 1985 7403 1986 7706 1987 7308 1988 7729 1989 7844 190 7911

Calculate the price index numbers for the years 1981-1990, taking the price of 1980 as the base. Also find the index numbers by taking the average of first six years as the base. Solution: By definition, the price index for given year (P0n) is computed by the

Pon =

Pn Price of following expression as: the given period commodity P0 100 = Price of the base period commodity

100

The index numbers for given period taking 1980 = 100, are given in the following Table.
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Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Price 6983 7222 7393 7343 7258 7403 7706 7308 7729 7844 7911

i. Pon = Pn/P0 100 100 103.42 105.93 105.16 103.94 106.01 110.35 104.65 110.68 112.33 113.29

ii. P0n = Pn/7267.67 100 96.08 99.37 101.78 101.04 99.87 101.86 106.03 100.55 106.35 107.93 108.85

Average of the price of first six years = (6983+7222+ +7403)/6 = 7267.67

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CHAIN BASE METHOD

Chain Base Method A fixed base method compare changes in the prices of commodities of several years with that of the base year. As time passes, the tastes and habits of the people changes due to the relative importance of the commodities, change in the quality of the commodities and discovery of new commodities. Therefore, it becomes necessary to shift the base year frequently and hence the chain base method is useful for construction of index numbers. In this method, the base period is not fixed but it changes from year to year. According to this method, the price of the preceding year is taken as base and thus the relatives are computed (called link relatives). These link relatives are expressed as percentages by multiplying them by 100.
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CHAIN BASE METHOD-continued

P( n 1) n = P( n 1) n Price of the given period commodity 100 Price of preceding period commodity Pn = 100 Pn 1

A sequence of link relatives is presented as: P01 , P12 , P23 ,...., P( n 1) n

These link relatives are can not be directly used for comparisons of several years. To make comparisons of index numbers for several years, the link relatives are converted back to fixed base. This process of conversion is called the changing process and the indices thus obtained are called chain indices. Mathematically, the various terms of chain indices are obtained by the following expressions.
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CHAIN BASE METHOD-continued

P 01 = P 02 ( f i r s t l i n k r e l a t i v e ) P 0 2 = P 0 1 P1 2 P 0 3 = P 0 1 P1 2 P 2 3 ....... ........ P 0 n = P 0 1 P1 2 P 2 3 . . . P n ( n 1 )

Price index P01 P02 P03 P04

Fixed base P1/P0 P2/P0 P3/P0 P4/P0 P1/P0

Chain base

P01 P12 = P1/P0 P2/P1 = P2/P0 = P02 P01 P12 P23 = P1/P0 P2/P1 P3/P2 = P3/P0 = P03 P01 P12 P23 P34 = P1/P0 P2/P1 P3/P2 P4/P3 = P04
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Example 5.2: The following present the prices (Rs.) per 20 kgs of wheat for the years 1980-1987. Calculate the chain indices taking 1980 as the base.
Year Price 1980 58 1981 58 1982 64 1983 64 1984 70 1985 80 1986 80 1987 83

Solution: To compute chain indices, first of all we calculate the link relatives by using the following formula.
P( n 1) n = Pn P ric e o f th e g iv e n p e rio d c o m m o d ity 100 = 100 P ric e o f p re c e d in g p e rio d c o m m o d ity Pn 1

Year 1980 1981 1982 1983 1984 1985 1986 1987

Price (unit) 58 58 64 64 70 80 80 83

Link Relatives 100 (58/58) 100 = 100 (64/58) 100 = 110.34 (64/64) 100 = 100 109.38 114.29 100 103.75
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Chain indices 100 (100100)/100 = 100 (100110.34)/100 = 110.34 (110.34100)/100 = 110.34 (110.34109.38)/100 = 120.69 137.94 137.94 143.11

STEPS IN CONSTRUCTION OF INDEX NUMBER

1. 2. 3. 4. 5. 6.

Purpose of index number Selection of commodities Collection of prices Selection of base period Selection of an appropriate average Selection of suitable weights

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WEIGHTED PRICE INDEX NUMBERS

1. PAASCHES PRICE INDEX NUMBER
P0 n =
P0 n =

Pn q n 100 P0 q n
Pn q 0 100 P0 q 0
n n n 0 0

2. 3. 4.

LASPEYRES PRICE INDEX NUMBER FISHERS PRICE INDEX NUMBER

P0n =

P q P q P q P q
0 n 0

100

MAESHAL EDGE-WORTH PRICE INDEX NUMBER

P0n
5.

P (q + q ) 100 = P (q +q )
n n 0 0 n 0

WALSH PRICE INDEX NUMBER

P0n

P = P

n 0

qnq0 qnq0

100

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NUMERICAL QUESTION
STATEMENT: Using the following data, showing -------------------------------During the years 1990 and 1995. Compute, Laspeyr, Paasche and Fisher price Index numbers. Base Period (1990) Commodity A B C D E Price 20 25 23 21 30 Quantity 15 20 18 17 25
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Current Period (1995) Price 25 28 26 28 40 Quantity 14 22 20 14 22

Base period (1990) Commodity A B C D E Total P0 q0

Current period (1995) P1 q1 P1q0 P1q1 P0q0 P0q1

20 25 23 21 30

15 20 18 17 25

25 28 26 28 40

14 22 20 14 22

375 560 468 476 1000

2879

350 616 520 392 880

2758

300 500 414 357 750

2321

280 550 460 294 660

2244

1. 2. 3.

Paasches price index for 1995: P01 = (2758/2244)*100 =122.91 Laspeyres price index for 1995: P01 = (2879/2321)*100 =124.04 Fishers price index for 1995: P01 = (2758/2244) (2879/2321) 100

= 123.47
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