ndex Numbers

Introduction

t
Economic

remain cons
nd
business
sanstant. It is
ilarly, output of possible that
data
change from time
to time. Fori
6
alis S i m i l a

commodity
a
is possible onl.nodity
sometimes
soetimes
the
For
price ofinstance, prices of all
h
changes IS sometimes and commodity rises andcommodities
possible only by means of rises a

al
a t i s t i c a l

nbers
devices which
help
the statistical
nean the:
we mean
measurement
in thesometimes
some falls. The
statistical methods.ds. Index numbers
sometimes
measurement of
es
a

place different points of

veltaking place at differ measures with ofsuch
the chane such
anges. In other words, by index are

ted only general pricelevels but

to time can be helpdfwhich relativegchanges
an like rather they measured. Application
Pplication e s nio general
general price
phenomenen

cost-of-living, help
help
numbers output, national income,
csihle. Index number
not possib
put, nationat in
in the of Index
nd numbers
ne
relative measurement of
measurement
are not

AT pOSSIOJejindex are used to businessactivities whose direct every

every suen
such
E cannot observe directly. measure the relative changes measurement
in some
Definition of Index Numbers phenomena which
Some important definitions of index numbers
are
given below
1. Index Numbers are a
specialized type of averages.
2Index Numbers arè devices for -M. Blair
related variables, measuring differences in the
magnitude of a group of
3 An Index Number is
statistical measure
a -Croxten and Cowden
of related variables with respect to time, designed to show changes in a variable or group
geographic location or other characteristics.
The definitions
-Spiegel
discussed above specify the
) Relative
following features of index numbers:
changes in the aggregates are measured by index numbers Index
MaYS present the (ii) numbers
Stions in base
changes taking place in some variable on an
average only (ii) By index numbers,
year and current year are compared.
JUses of Index
In present times,
Numbers
PSENt times, the importance of index numbers is increasing. Nowadays, they are being used
onomics
Dmatandand busind
business fields. To quote Simpson and Kafka, "Index Numbers are economie
arometers". The main
of indexAn index number makes possible the measurement of such
uses numbers are the followings:
exTo Simplify Complexities:
mplex nanges whose direct measurement is not numbers are used
easur
neasure the Changes
changes in
C
possible. In other words, index
quantity which cannot observe directly.
some we
238 Allowances.
Business s
and Dearness
By index numbe
in Fixation of Salary and salary fixation.
2) Helpful can properly make wage hey dete
deter
and other employees
on the basis of index numhe ey
govemment allowance for employces
instalment of deamess give the knowledge as to
IndeN numbers at
Helpful in Predictions:

basis of these changes alone, ctions

predictions about thee Chag
the futur changes y
occumad in the past. On the ate no
barometers.
numbers are economic
Thus, index
Index numbers make possible the compara
4Helpful in Comparison: in the variabless are ared
phenwnena. By index numbers, the
relative changes occuring
time and space.
determined
of data on the basis of
simplifies the comparison
Measure Purchasing Power of Money: By index numbers,
the changes tak
tak1ng a
5) To
can also be measured.
the purchasing power of money
Index numbers measures the changes taking place in businesu
(6) Useful in Business:
and prove very useful in making a comparative study of those changes, e,g., sales, changes in o
function like a barometer.
and value, etc. Thus, index numbers, for a businessman,
To sum up, index numbers are the sign and guide posts along the business highway that ndi
to the businessmen how he should drive or manage his affairs.

Limitations of Index Numbers

Though index numbers are extremely useful statistical devices, yet they have some limiane
which are detailed as follows:
()Index numbers measure relative changes in different phenomena. They do not alwayse
cent per cent true. Index numbers are true only on the average.
i A given type of index numbers is not suitable for all the purposes. MultipurpoSe n
numbers cannot be constructed.
N o consideration is given to the changes
taking place in the quality of a commou
constructing the index numbers.
) Bias in the selection of base year and selection of representatives sometimCS leads
misleading results.
(v) Jndex numbers lack in perfect accuracy because they are mostly construcicu on the basw.

sample commodities.
Types of Index Numbers
Index numbers are classified on the
basis of the
phenomena whose changes ncy
measure

economic and business, index numbers

can be classified
into the following types
Price lndex
Price Index Numbers: Price index numbers are most popular and commonly
numbers. These index
number measure the changes in
mmodities orgroup
prices
commodities consumed n ne given period with feference to of some comn
riod) These are
the base period, Ine>.
Wholesale Price Index Number: It measures the
price levelo

commodity. changes in the genet

ia Retail Price Index Number: lt retail pr
commodities hich are bought measures the general changes
and sold in nges in
in
the

the retail
market.
 Numbers-/

Quanantity Index Numbers: 239

anges in the
physical volumeQuantity
physical
of
index
numbers helps
of pad
mbers
goods produced heclps us in measuring and comparing
es
of riculture and strial or sold or
lue Index Numbers: production are included in purchased in a give
Value index this
modities oF group of
commodities numbers measure thecategory
consumed or
purchased in the changes
A p e r i o d .
in

Smple and.Aggregative Index

givensperiod with reference to
Numbers: On the basis
eto the construction ot an index, index
numbers of the numberrof commodities that
are classified
simple Index Numbers: When index into two
.

these are termed numbers are

categories
constructed for individual
as
simple index numbers. commoua
Aggregative (or composite)
Index Numbers: When
of
group
gro commodities, these are known as index numbers are constructed for a
Cost of Living Index Number: Cost of aggregative (or composite) index numbers.
nbers. They help in living index numbers are also called consumer
*x
numbe:

from one time

nmodity
comparison
to
of average
period change in consumption and price
expendinure
ommo
another. It shows the
afa particular class of consumers. average change in consumer expenditure
ASpecial Purpose Index Numbers: Some index
numbers areconstructed for some speciiic
nfposes or aspects. They measure the
average change
specific purpose.
as
compared to the base period of any
Problems in The Construction of Index Numbers
A number of problems up while constructing the index numbers. The
come
them are as follows: important among
Purpose of Index Number: Index numbers are of many types as they are constructed for
different purposes. It is very essential to fix the
purpose before
because selection of commodities, their prices, fixation of their constructing
an index number,

weights, etc., depend on the very

purpose of index numbers. There can be many purposes of an index
number-measurement of
changes in retail prices or measurement of changes in wholesale prices, etc.
Selection of Items: Another important problem in the construction of index numbers is the
Selection of items. The following things should be considered while makinga selection of items:
only those items should be selected which représent the taste, habit, custom and needs of the
elated group of people, (ii) the selected items should be standardised and of classified feature,
i n selection of
items, their quality too must be considered, (V) the number of items must be
ghand they should be of current quality, and (v) the selected items must be classified into
lerent groups and sub-groups.
Selection of Prices: After making the selection of items, the next arises the problem ot
selectio prices.
Tesof Price can be of both types-retáil and wholesale. Thus, whether wholesale or
wh es are to be used, the decision depends upon the purpose of index number.\Otten,
1olesalee
prices
s arare taken in the construction of index numbers. In addition, prices should be picked
from that place where the related items are traded most.
4) Selection ofBase year: Another important problem in the construction of index numbers is
Telated to the
selecti
I C c t i o n ofbase year. A base year has to be selected for making an index number.
 240

be determined, is known as base year, Inda.

Busines SStaliraes
are to ex
The for which changes
vear
as 100. In selecting
a base year,
the following things are number of ba
is always taken and no unusual event like Eartha
pt nin min
mind
should be a normal year
Base year
should have taken place
in that year, Flood, Wa
should not be very far in past,
() Base year
base year should be close to the current year.
(i) So far as possible,
should not be too old or too distant.
(i) Base year
problem in making of index 1
(5) Selection of Weightsi Another important isis mbers
or items( In fact, all commodities includedinrS to a
weights to different commodities
of index numbers do not have equal importance. Therefore, to have accurate resulte s t u
constructioge
are assigned weights according
to their importance. There are two ways of
)Quantity, (ii) Value. Weights decided in the construction of index numbers signing weighi
commodt
should be lo
accurate and rational
6 Selection of an Average: The selection of an average is also a significant prohlem
a in te
preparation of index numbers. Averages can be of several types. Theor
oretically, any averag
used but in practice, usually arithmetic mean and geometric mean are used. Geometricn
considered to be the best for the construction of index numbers as this is most suitable for mee an
relative changes but due to the difficulties of computation in place of geometric mean. arit
mean is most often used in the construction of index numbers. hmetic
FY Section of an Appropriate Formula: Various formulae can be used in the constructio
index numbers but it is very essential to select the most suitable out of them.)This selection denen
upon the purpose of index number and availability of data. Fisher's formula which is calda
Fisher's Ideal Index, is considered to be the best.

Methods of Constructing Index Numbers

Different methods used in are
constructing the index numbers which, from the view point m
convenience of study, have been
presented by the following chart:
Methods of Constructing Index Numbers

Unweighted Simple Index Numbers

or

Weighted Index Numbers

Simple Aggregative
Method Simple Average of Price
Method Relatives|| Weighted Aggregative Weighted Averageot
Price Relatives Meb
Method

(a) Laspeyre's Method

(b) Paasche's Method
(c) Fisher's Method
(d) Dorbish.and
(e) Marshall and Bowley's Method
Kelly's MethodEdgeworth's Method
 latudee y"
NUOery-

7 Simple
or Unweighted Index Numbers
dex
or unweighted inde numbers are those oncs the construction of which ali
in

ties
are given cqual importanee.
1 There are two methods of their construction
simple Aggregative Method.

simple Average ofPrice Relatives Method.

Aggregative Method
( )Simple this method, sum of current year's prices is divided
s the mplest method. In by the sum of
's prices and the quotient is multiplied by 100. The following formula is used:
Var
s pr
A

Po1 PLx 100

Po
Year
Where. p =
Aggregate of Prices in Current
Year
po =Aggregate of Prices in Base
Po1 Price Index
=

be illustrated with the following examples:

This method can
index number for 2014 based on 2005 using Simple Aggregative
Fumple 1Construct priçe
Method:
Price in 2005 (in 7) Price in 2014 (in )
Commodity
50 80
A
40 60
B
10 20
C
10
D
8
E

of Price Index Number

Construction
Solution:
Price in 2005 (Po) Price in 2014 (P1)
Commodity
80
50
A

40
60
B
20
10
C
10
D
8
E
2P-178
po= 107

P..
Po1 =Pl y100-x 100 166.36
107
EPo
 242
Method
siness Stati
Merits and Demerits of Simple Aggregate
number construction is very casy but
Simple aggregative mnethod ofindex
it.
when the prices of all commodities have been expressed in the same unit. If units be applied ,
are differenm,
results will be misleading.
Relatives Method
o (2) Simple Average of Price
In this method, first of all. the price relatives of the commodities or
ems are
compute the price relatives, price in current year (P1) is divided by the price in base found out
then, the quotient is multiplied with 100. In terms of formula,
Current year' s x100
Price Relative =- or P=PLx100
Base year'sPrice Po
After this. using Arithmetic average or Geometric average, or Median, we find the avera
price relatives. erage ci
(When Arithmetic mean is used, then the following formula is used:

PLx100
Po Po
N
Where, N number of items or commodities.
=

(i) When Geometric Mean is used, then the

following formula is used:
o1=Antilog2 log P
N

Where, P=lx100
Po
(iüi) When Median is used, the
following formula is used:
PaSize ofN+1
2
In practice, arithmetic mean is often used.
The following example illustrates the
following are the prices of procedure
of the method:
Example 2. The
index based on commodities in 2009 and 2014. priee
price relatives taking
(ii) geometric mean and 2009 as base year using () arCOns mean
(iii) median.
Commodity A
B E
C D
Price in 2009
50
20
40 80 10
Price in 2014 70 20
60
90 120
PrNUmbers-/ 243
Deice Index using Arithmetic Mean of Price Relatives
)Price

Commodity Price in 2009 Price in 2014 Price Relatives (P)

tion
Po) (P) p-l 100
Po

A 50 70 140.0

B 40 60 150.0
80 90 112.5

D 110 120 109.1

E 20 20 100.00

N=5 Px100= 611.6

Po

Using Arithmetic Mean, the formula used is:

Px100
Po1- PoN 611.6 122.32
Mean of Price Relatives
(i) Price Index using Geometric
Price in 2014 log P
Commodity Price in 2009
P-x100
Po P1 Po

A 50 70 140 2.1461
B 40 60 150 2.1761
80 90 112.5 2.0512

110 120 109.1 2.0378

D
E 20 20 100 2.0000

log P 10.4112

Using Geometric Mean, the formula used is:

(10.4112
(E log P= Antilog10.4112)
PoAntilog
N

= Antilog (2.0822) =120:9

(in) Price Index using Median of Price Relatives

Commodity Price Relatives of 2014 Price Relatives arranged in

ascending order
A 140 100.0
109.1
B 150
112.5 112.5
140.0
109.1
E 100 150.0
2
PoL=Size of*|th item
Business Statlig
Size ofth item
3 r d item = 112.5

of Simple Index Numbers on the Basis of

of Avera.
Average Price
Construçtion
f the simple index numbers are constructed on the basis of average price:
ice as
compute the average price of each commodity and this is taken as base.
base. The Dr
The base, irslby e
price relatives:
calculated by using the following formula: S are the-

Price Relative =
urrent Year's Pricex100
Average Price
After this, using arithmetic mean, we find the average of price relatives. This avera
index numbers.The following example illustrate the procedure of this method: givesh
Example3. Find index number for the three years, taking average price as base by ni
relative method:'
Price per quintal (F)
Year A B C
2012 3 5 8
2013 4

2014 6

Solution: Average price of A-3+5+7-3=5

3

B =2*4+6
Average price of 3

Average price of C =8*6+7_:

3

Commodity| Average 2012 2013 2014

price PR
PR PR
Po P1
A 3 5 x100=140
x100 60 x100 =100
B 5 5 6 x100 12
4 x100 = 80
x100 =100
5
C 8 8 6
x100 =114.29 x100
7
8571
360
Total of price relatives
274.29 265.71
120
Average of price relatives or
91.43 88.57
price index
 245

MPORTANTTYPICAL EXAMPLE
rom
Leam the following
the followin data, construct years with average
Price Index Number for threearithmetic
price
as base by simple average of price relatives method using mean:

Rate per rupee/

Wheat Cotton Oil
Year
2 kg
10kg 4 kg

8kkg 2.5 kg 2k

5kkg 2.0 kg 1 kg
III

say price scale

given price per rupee. First convert these prices on common
a
olution:
We are
=20.
per 100 kg. Thus, the price of wheat would be = 1 0 , + =12.50,+
8 10

Similarly, prices of cotton and oil would be

100
=25 100 =40, 50 and
4 25 2
100010050.00_j00.
2 2 1
10+12.50 +20 = 14.17
Average Price of Wheat =

Average Price of Cotton 25+40+50 38.33

50+50+100
= 66.67
Average Price of Oil =.

Construction of Price Index Number

1st Year 2nd Year 3rd Year

Commodity Units Average
Price
(Po) Price Price Price Price Price Price
(P) Relatives (P2) Relatives (P3) Relatives

P1 x 100 P2 x100 P3 100

Po Po Po

Wheat Per Qt. 14.17 10 70.57 12.50 88.21 20 141.14

Cotton Per Qtl 38.33 25 65.22 40 104.36 50 130.45

Oil Per Qt. 50 75 50 75 100 150.00

66.67

421.59
Total of Price Relatives 210.79 267.57

Average of Price Relatives 70.26 89.19 140.53

246
Business Slaliy
EXERCISE1
Construct the following indices by taking 2012 as the base:
Simple aggregative price index
(i) Index of average of price relatives
Items A B C D
Prices (2012): 6 2 4
10
Prices (2013): 10 2
8
6
12
Prices (2014):" 15 3
2
8
14
[Ans. () 2013 140 and 2014 186.66 (i) 2013
-
-

Compute price index based on price relatives by using both

a 137.32 and 2014
201 4-
mean: arithmetic mean and genmerme

Commodity A B C D E
Price in 2009 (T) 200 300 100 250 400 S00
Price in 2014 () 250 300 150 350 450 550

[Ans. ( 117.143, (i) 122.92, 12

3Prepare price index numbers for three years taking the
average of price relative method: average price as base using sim
Price per Quintal ()
Year Wheat Cotton Oil
2012
100 25 30
2013
99
20 25
2014
99
15 30

Ans. 110.52, 95.97,93

Construct the price index number for three
simple average of price relative method: years taking the average price as
Year
Rate per rupee
Wheat Rice Sugar
kgm 1 kgm 0.400 kgm
1.6 kgm 0.400kgm
0.800 kgm
kgm 0.750 kgm 0.250 kgm

[Ans. 79.2, 92.1, 1

Find index
out price inde numbers for 2012, 2013 and
nd gcometrie mean: 2014 247
iian taking 2011 as base by
Group 2011
using mean,
2012
8 2013
12 2014
B 32 6 20
40
48 60
C 16 20
32 40

[Ans.Po1 (AM)=133.3, 183.3,229.2

PoI (M)=125, 200, 250, Po1 (GM) =132.83,
181.7,227.1]