Tests of Adequacy of Index Number

Formulae

Dr Parmila
Assistant Professor of Commerce
Kanya Mahavidyalaya Kharkhoda
Sonipat
 Tests of Adequacy of Index Number
Formulae

Prof. Fisher has given the following tests to

select an appropriate formula:

 Time Reversal Test – TRT

 Factor Reversal Test- FRT
 Circular Test
Tests of Adequacy of Index Number Formulae

 Time Reversal Test – TRT

Illustrating this test, Prof Fisher remarks, “The test is that
the formula for calculating an index number should be such that it
will give the same ratio between one point of comparison and the
other, no matter which of the two is taken as base”
Time Reversal Test is satisfied when
1
P01 = --------- or P01 X P10 = 1
P10

Where,
P01 = Price index for the year one with zero as base
P10 = Price index for the year zero with one as base
Tests of Adequacy of Index Number Formulae

 Time Reversal Test – TRT

This test is not satisfied by simple A.M. of price relative, Laspeyre and
Paasche’s formula. But this test is satisfied by Fisher’s Ideal Index,
Marshall-Edgeworth Index and simple G.M. of Price Relative.

Laspeyre’s Formula :
∑ p1 q0
P01 = --------- X 100
∑ p0 q0

∑ p0 q1
P10 = --------- X 100 Since P01 X P10 ≠ 1
∑ p1q1

The Laspeyre’s Formula does not satisfied the TRT.

Tests of Adequacy of Index Number Formulae

 Time Reversal Test – TRT

Paasche’s formula

∑ p1 q1
P01 = --------- X 100
∑ p0 q1

∑ p0 q0
P10 = --------- X 100 Since P01 X P10 ≠ 1
∑ p1q0

The Paasche’s Formula does not satisfied the TRT.

Tests of Adequacy of Index Number Formulae
 Time Reversal Test – TRT
Fisher’s formula
__________________
∑ p1 q0 ∑ p1 q1
P01 = --------- X ---------- X 100
∑ p0 q0 ∑ p0 q1

__________________
∑ p0q1 ∑ p0 q0
P10 = --------- X ---------- X 100
∑ p1q1 ∑ p1 q0

Since P01 X P10 = 1

The fisher’s Formula does satisfied the TRT.

Tests of Adequacy of Index Number Formulae
 Time Reversal Test – TRT
Dorbish and Bowley’s formula
∑ p1 q0 ∑ p1 q 1
P01 = --------- + ----------
∑ p 0 q0 ∑ p0 q 1
_____________________________

∑ p0 q1 ∑ p0 q 0
P10 = --------- + ----------
∑ p 1 q1 ∑ p1 q 0
_____________________________

Since P01 X P10 ≠ 1

The Dorbish and Bowley’s Formula does not satisfied the TRT.
Tests of Adequacy of Index Number Formulae

 Time Reversal Test – TRT

Marshall- Edgeworth’s formula

∑ p1 q0 + ∑ p1 q1
P01 = ---------------------------- X 100
∑ p0 q0 + ∑ p 0 q1

∑ p0 q1 + ∑ p0 q0
P10 = --------------------------- X 100
∑ p1 q1 + ∑ p1q0

Since P01 X P10 = 1

The Marshall- Edgeworth’s formula does satisfied the TRT.

Tests of Adequacy of Index Number Formulae

 FactorReversal Test – FRT

According to Prof Fisher, “Just as our formula should permit the interchange of two
times without giving inconsisting results, so it ought to permit interchange of prices and
quantities without giving inconsistent results, i.e., the two results multiplied together should
give the true value ratio.”
Factor Reversal Test is satisfied when

∑ p1 q1
P01 X Q01 = ---------
∑ p 0 q0

Where,
P01 = Price index for the year one with zero as base
Q01 = Quantity index for the year one with zero as base
Tests of Adequacy of Index Number Formulae

 Factor Reversal Test – FRT

This test is not satisfied by Laspeyre, Paasche’s formula and Marshall-Edgeworth. But this test
is satisfied by Fisher’s Ideal Index.

Laspeyre’s Formula :
∑ p1 q0
P01 = --------- X 100
∑ p0 q0

∑ q1 p0
Q01 = --------- X 100
∑ q0p0

∑ p1 q1
P01 X Q01 ≠ ---------
∑ p0 q0

The Laspeyre’s Formula does not satisfied the FRT.

Tests of Adequacy of Index Number Formulae

 Factor Reversal Test – FRT

Paasche’s formula

∑ p1 q1
P01 = --------- X 100
∑ p0 q1

∑ q1 p1
Q01 = --------- X 100
∑ q0p1

∑ p1 q1
P01 X Q01 ≠ ---------
∑ p 0 q0
The Paasche’s Formula does not satisfied the FRT.
Tests of Adequacy of Index Number Formulae
 Factor Reversal Test – FRT
Fisher’s formula
__________________
∑ p1 q0 ∑ p1 q1
P01 = --------- X ---------- X 100
∑ p0 q0 ∑ p0 q1

___________________
∑ q1 p 0 ∑ q1 p1
Q01 = --------- X ---------- X 100
∑ q0 p0 ∑ q0 p1

∑ p1 q1
P01 X Q01 = ---------
∑ p0 q0

The fisher’s Formula does satisfied the FRT.

Tests of Adequacy of Index Number Formulae
 Factor Reversal Test – FRT
Dorbish and Bowley’s formula
∑ p1 q0 ∑ p1 q1
P01 = --------- + ----------
∑ p0 q0 ∑ p 0 q1
_____________________________

∑ q1 p0 ∑ q1 p1
Q01 = --------- + ----------
∑ q0 p0 ∑ q0 p1
_____________________________

∑ p1 q1
P01 X Q01 ≠ ---------
∑ p0 q 0

The Dorbish and Bowley’s Formula does not satisfied the FRT.
Tests of Adequacy of Index Number Formulae

 Factor Reversal Test – FRT

Marshall- Edgeworth’s formula

∑ p1 q0 + ∑ p1 q1
P01 = ---------------------------- X 100
∑ p0 q0 + ∑ p0 q1

∑ q1 p0 + ∑ q1 p1
Q01 = ---------------------------- X 100
∑ q0 p0 + ∑ q0 p1

∑ p 1 q1
P01 X Q01 ≠ ---------
∑ p0 q0

The Marshall- Edgeworth’s formula does not satisfied the FRT.

Tests of Adequacy of Index Number Formulae

 Circular Test
According to this test, if there are three time periods 0,1,2
and price index od period 1 relative to 0 (P01), price
index of period 2 relative to period 1 (P12) and price
index of period 0 relative to period 2 (P20) are computed,
then the product of these three indices must be unity.
Symbolically: P2 P0
P01 X P12 X P20 = 1
P1
Tests of Adequacy of Index Number Formulae

 Circular Test

Circular test is satisfied by simple aggregative index

only.
Thanks