Ch.3.

Index Number
Index Number is a statistical technique to compare the changes in prices of
commodities, industrial and mineral production, sales, import, export etc.

OR

Index number is a statistical technique to compare the values of variable or group

of related variables of base year with respect to current year.

The group of related variable may be prices of specified commodities quantities of

industrial production, volume of imports, exports. Two different situations may be
two different times or places.

It was first developed by Italian Economist Mr. Carli in 1764 for comparison of
prices of commodities . Index number is a special type of average which is always
expressed in percentage. Index number for base year is always considered as 100.
We observe that the prices of commodities changes from time to time , place to
place or area to area. The apparatus barometer reflects changes in atmospheric
pressure likewise, index number reflects the changes in economics activities.
Hence, Index number is also called as Economic Baromeer.

A period for which index number is determined is called as current period.

And the period of comparison or with respect to which index number is determined
is called as base period.

Following are the some areas where Index Number is popularly used.

a. Bombay Stock Exchange(BSE)

b. National Stock Exchange (NSE)
c. All India wholesale price index Number.
d. Consumer Price Index Number
e. Index Number of Industrial Production (1993-94) as base year.
f. Index Number of Agricultural production
g. Cost Inflation Index
Notations:
0: base year
 1: Current year
p0: Prices in base year
p1: Prices in current year
q0: Quantity in base year
q1:Quantity in current year
w: weight of the commodity
I: Link relative or Price Relative
= 100

P01: Price Index Number of base year with respect to current year.

Q01: Quantity Index Number of base year with respect to current year
V01: Value Index Number of base year with respect to current year

Types of Index Number:

There are three types of Index Number:

1. Price Index Number(P01)

2. Quantity Index Number (Q01:)
3. Value Index Number (V01)
1. Price Index Number(P01)
Price Index Number is a statistical technique to compare the prices of
variable or group of related variable in the base year with respect to current
year.
It is denoted by P01
 Methods of Construction of Price Index Number:
Mainly there are two methods of Construction of Price Index Number
1. Unweighted Price Index Number:
a. Simple Aggregate Method
b. Simple Average Price Relative Method
2. Weighted Price Index Number :
a. Weighted Aggregate Method
b. Weighted Average of Price Relative Method.
1. Unweighted Price Index Number:
It is given by
ℎ
= 100
ℎ
∑
= 100
∑
Similarly, Quantity index number is given by;

ℎ
= 100
ℎ
∑
= 100
∑
2. Simple average of Price Index Number:
It is given by;

∑
` = , Where I= 100 = Link relative or Price Relative
N= Number of commodities
In unweighted price index number, all the commodities having equal
weightage ( importance) and that is 1.

Illustratve Examples;
Ex1. Calculate price index number for 2015 with 2020 as a base year by
using
a. Simple aggregate method
b. Simple average of price relative method
 For the following data:
Prices in 2015 40 60 20 50 30 10
Prices in 2020 50 60 30 70 40 20
Solution:

P0 P1 1 1. Simple Aggregate Method=

= 100
0 ∑
40 50 125 = 100
∑
60 60 100
20 30 150
270
50 70 140 =
100
30 40 133.33 210
10 20 200 01 = 128.57
∑ 0=210 ∑ 1=270 ∑ =848.33 2. Simple average of Price
Index Number:
∑ .
` = = = 141.3833

2. Weighted Price Index Number :

According different weighting system , different index numbers are

obtained. Here, different weights are suggested by different persons
therefore there are various number of index numbers.
a. Weighted Aggregate Method:

It is given by;
∑
=∑

i) Lasperys Price Index Number: He considered

weight as a quantity during base year ( w=q0)

It is given by
∑
=∑
 ii) Paasches Price Index Number : ( w=q1)

He considered weight as quantities in the current year. It is given by

∑
=∑ 100

iii) Fishers Price Index Number:

Geometric Mean between Lasperys and Paasches price index number is called as
Fishers price index number. i.e.

Fisher price index number is also called as Fisher ideal price index number because
it satisfies unit test, reversible test, factor reversible, circular test etc.

b) Weighted Average of Price Relative Index Number OR Family

Budget Method OR Cost of Living Index Number

It is given by:
∑
=
∑

Where = 100

Illustrative Examples:

Ex-1 Calculate price index number for the following data for the year 2020 taking
2015 as a base year by using Lasperys, Paasches and Fishers price index number

Commodity 2020 2015

Price Quantity Price Quantity
A 20 8 40 6
B 50 10 60 5
C 40 15 50 10
D 20 20 20 15
Solution:
Commodity P0 q0 P1 q1 q 0p 0 q 0p 1 q 1p 0 q 1p 1
A 20 8 40 6 160 320 120 240
B 50 10 60 5 500 600 250 300
C 40 15 50 10 600 750 400 500
D 20 20 20 15 400 400 300 300
q0p0 ∑ q0p1 = ∑ q1p0 = ∑ q1p1 =
= 1660
2070 1070 1340

1. Laspery’s Price Index Number

∑ 0 1 2070
= 100 = 100 = 124.6988
∑ 0 0 1660

2. Paasche’s Price Index Number

∑ 1 1 1340
= 100 = 100 = 125.2336
∑ 1 0 1070

3. Fisher’s Price Index Number

= = √124.6988 125.2336 = √15616.4796 = 124.9659

Problems in the Construction of Index Number:

Following are the problems in the construction of Index Number:

1. Purpose of Index Number:-

The purpose for which index number is constructed should be mentioned

at the beginning clearly unambiguously. Scope of index number should
also be defined clearly.
For example, if we want to construct a consumer price index
numbers then appropriate commodities should be selected. Similarly, a
class of people for which the index number is to be constructed should
be clearly stated. Thus, defining the purpose of index number helps to
selection of commodities, base period, selection of weights etc.

2. Selection of Commodities:-

Selection of commodities is the next problem in the construction of

index number. If the Purpose of index number is clearly defined then
related commodities can be selected for the construction of index
number. If the purpose of index number is to construction of index
number for common people. Then related commodities can be
selected like food, cloths, medicine, education etc. These are the
important related commodities for the common people. The essential
commodities for the common people are food, clothes and shelter. If
we select the luxuries commodities, fare of airplane, price of air
condition this will be meaningful commodities. The commodities
should be representatives of tastes, customs and necessities of group
of population for which index number is constructed. There are no
rigid rules for selection of commodities. Number of commodities
should not be too large or not too small. Inclusion of large number of
commodities
3. Selection of base Period:-
Index number compare the prices between two periods namely,
base period and current period. So base period is the most
important problem for construction index number. The base period
should be a period for which appropriate figures are available. A
period at economic importance may be preferably chosen. The
base period should be base period. It means that there should not
be abnormality such as war, flood, earthquake, diseases like
corona, swine flew etc. It can be noticed that for the years with
 above mentioned abnormality condition, economic instability will
be observed. Hence base period should be normal. The base period
should not be too distant. Sometimes in the mean while some old
commodities get out of use and new commodities get introduced.
The base period should not be too small. The base period is too
short (for example, a single day) the prices are highly unstable. On
the other hand, if the period is too large (for example, five years)
then prices undergo may variations. Therefore, there is very
essential to that prices of selected commodities should be proper
and adequate.
4. Collection of Data:

Data may be price quotations or quantity produced or quantity

imported etc depending upon the purpose of index numbers. The
data should be collected from reliable agencies, standard trade
journals, periodical reports, official publications etc. The collected
data should be accurate and proper representative. For consumer’s
price index numbers, price quotations should be collected from
trusted agencies. Prices may vary from place to place, shop to
shop, person to person and quality to quality. Therefore, prices
should be collected with utmost care. As per requirement, retail or
wholesale prices should be collected. Sometimes prices may be
quoted as number of Rs. per unit quantity.
5. Selection of Weights:-
Weighted average is more appropriate than simple average. Weight
is a device of giving due or proper importance to the commodity. If
weights are not attached, all commodities are considered equally
important. Since, changes in prices of different commodities will
have different influence on average, weight is essential. Some
time quantities during base year and current year considered as
 weights. In Laspery’s price index number, quantity during base
year is considered as weight and in Paasche’s price index number
quantity in the period considered as weight. Sometimes = 0 0
will be considered as a weight.
6. Selection of type of Averages:-
We know that, index number is a special type of average and
which is always expressed in average. Index number for base
period is always considered as 100. In order to combine the data,
we need to use appropriate measure of central tendency. A.M. is
suitable in most of the situations, since it is a simple and good
average. Sometimes Geometric Mean is used for construction
index number. Fisher index number is calculated by using G.M.

Cost of Living Index Number (CLI):

Cost of Living Index Number or consumer’s price index number is a number

which measures the average change in the retail price paid by a particular class of
people at a particular place for a select of specified commodities and services, over
two different time period.

Wholesale price index numbers are not useful in measuring the effect of change in
prices on consumer. Hence especially, in order to study the effect of changes in
prices on family budges of different classes in a society, the cost living index
numbers are employed. Therefore costs of Cost of Living Index Number are totally
based on retail prices. It is also essential to calculate index number for different
classes of people separately.

Main Steps in Construction of Cost of Living Index Number:

Following are the main steps in the construction of CLI;

 a. Scope:

The scope of CLI should be clearly defined. In other word, group of people and
geographical area for which index number is to be constructed should be defined in
the beginning because there is a wide variation in the type, quality and
consumption pattern of commodities which they use from place to place and class
to class. Defining scope and collection of prices of different commodities and
purpose will help in selection of commodities, base period, weights etc.

b. Family Budget Enquiry:

The aim of family budget enquiry is to collect the

information regarding commodities and services; those are used in group under
consideration which is referred as basket. Commodity-wise expenses and
consumption is also noted. This helps in assigning weights and collection of prices
of commodities. The prices of commodities changes from place to place or shop to
shop or person to person.

c. Collection of Price Data:

The retail prices of data are to be collected. Collection of retail prices is somewhat
difficult task. The retail prices of commodities changes from place to place or shop
to shop or person to person. Therefore, prices should be taken from representative
and reliable shops by trained agencies. Average of price quotations is considered to
be proper. Prices should be collected for base period as well as current period.

d. Selection of Weighs:

There are two methods to select the weights viz:

1. Weights proportional to the quantities consumed.

2. Weights proportional to the expenditure incurred

Methods of Construction of Cost of Living Index Number:

There are two methods to construct CLI

1. Aggregate Expenditure Method:

It is given by
 ∑
Cost of Living Index Number= ∑ 100

This formula is same as Lasperys price index number. Here quantity during base
year is considered as a weight. Notations have their usual meanings.

2. Family Budget Method:

This method uses expenditures in base-period as weights. Hence, this method

is also referred as weighted average of price relatives. By means of family
budget enquiry commodity-wise total expenditure is determined. We denote it
as w. To calculate CLI, current year prices of commodities are expressed as
percentage of the corresponding prices in base period.
∑
Cost of Living Index Number= ∑
Ex-1 A family budget survey of middle class families gives the following
data:

Items Prices in Year

2018 in Rs 2019 in Rs
Food 10000 11000 35%
Fuel & Lighting 1500 1750 10%
Clothing 3000 4000 20%
Housing Rent 5000 5000 20%
Misc 3000 5000 15%
Calculate cost of living index number for the year 2019 by taking 2018 as a
base year.
Solution:
Items P0 P1 W WI
1
= 100
0
Food 10000 11000 110 35 3850
Fuel & 1500 1750 116.66 10 1166.66
Lighting
Clothing 3000 4000 133.33 20 2666.66
Housing 5000 5000 100 20 2000
Rent
Misc 3000 5000 166.66 15 2500
 = 12183.334
∑ .
Cost of Living Index Number= = = 285

Ex.2 Calculate Cost of Living Index Number for the following data:

Group Index Number Weight

(I) (W)
Food 350 50
Fuel & Lighting 200 10
Clothing 240 10
Housing Rent 160 10
Misc 250 20

Solution:
Group Index Weight WI
Number (I) (W)
Food 350 50 17500
Fuel & Lighting 200 10 2000
Clothing 240 10 2400
Housing Rent 160 10 1600
Misc 250 20 5000
= 28500

∑
Cost of Living Index Number= = = 285

Ex-3. Cost of living index number of the following data is known to be 126.2.
Obtain the missing weight.

Commodity A B C D E
Index 130 120 125 115 120
Number
Weight 60 20 * 6 4

Solution:
Suppose the missing weight is x. We calculate cost of living index number as
usual and equate to given value 126.2.

Commodity Index Number (I) W WI

A 130 60 7800
B 120 20 2400
C 125 X 125x
D 115 6 690
E 120 4 480
= 90 + = 11370 + 125
∑
Cost of living index number= ∑

11370 +
126.2 =
90 +
126.2 (90 + ) = 11370 + 125

126.2 90 + 126.2 = 11370 + 125

11358 + 126.2 = 11370 + 125

126.2 − 125 = 11370 − 11358

1.2 = 12
12
= = 10
1.2
Uses of Index Number:

1. Index numbers are useful in measuring the changes in prices, production,

imports, exports, stock markets etc. Cost of inflation index number helps as to
know the appreciation of assets.
2. Index number helps in comparing the economic and business activities for two
different periods.
3. Index number helps in planning and Policy Making.
4. Index number ha.elps in finding real income or purchasing power of money.
5. Index numbers are used to fix dearness allowances of employees for adjusting
inflations.
 6. Index number gives the progress of industry, trends in stock markets.
7. Index number helps in finding real GDP or net national product which is the
main component in national income.
8. Index number are useful in measuring the rate of inflation

Multiple Choice Questions

1. Index number for base year is always considered as------

a. 100 b.101 c. 201 d. 1000
2. Index number is a special type of ----------
a. Average b. dispersion c. correlation d. None of the above
3. Index number is always expressed in ----------
a. Percentage b) ratio c. proportion d. None of the above
4. Index number is also called as-----------
a. Economic barometer b. Parameter c. Constant
d. None of the above

5. Which index number is called as ideal index numbr.

a. Lasperys b. Paasches c. Fisher d. None of the above

6. In Lasperys price index number weight is considered as---------

a. quantity in base year b. quantity during current year

c . prices in base year d. prices in current year.

7. In Paasches price index number weight is considered as---------

a. quantity in base year b. quantity in current year

c. prices in base year d. prices in current year.

8. Fishers price index number is the -------

a. A.M. of Lasperys and Paasches I.N.

b. G.M. of Lasperys and Paasches I.N.

c Difference between Lasperys and Paasches I.N

d. None of the above.

9. A period for which index number is determined is called as ------

a. current period. b. base period c. Normal period. d. None of

the above
10. The period of comparison or with respect to which index number is
determined is called as------
a. base period. b. current period c. Normal period d. None of the
above