CA Foundation – Mathematics, Stats and LR | Revision Notes | Index Number

INDEX NUMBER

Just as the arithmetic mean is used to represent a set of values, an index number is
used to represent a set of values over two or more different periods or localities.
Use
Also when numbers are unwieldy (too large), we use index numbers instead of
absolute numbers for analysis.
An index number is a ratio of two or more time periods are involved, one of which
Definition
is the base time period. Ex. NSE, BSE, WPI, CPI etc.
Selection of → Samples used should be representative of population.
Data Use random sampling
→ Method of computation should be consistent to ensure
comparison
→ Selection of commodities is challenging as their
relative importance keeps on changing with time
Base Period → It should be normal and not affected by extraordinary
events
→ Should be recent and not distant old
Issues
Selection of Due consideration should be given to the relative
Involved
Weights importance of each variable which relates to the purpose
for which the index is to be used.
Use of GM is better measure of relatives but for most of the
Averages indices arithmetic mean is used because of its simplicity.
Choice of For Prices, whether retail or wholesale
Variables For Quantity, whether average for a period or end of the
period
Selection of This will be covered below. There are multiple formulas.
Formula
Ratio of the price of single commodity in a given period to its price in another
period.
𝑃𝑛
Price Relative Price Relative =
𝑃0
𝑃
To be expressed as Percentage = 𝑃𝑛 × 100
0
Simple Σ𝑃 Refer:
Aggregative × 100 Page
Σ𝑃 19.5
Method
First calculate relatives for all commodities and then Refer:
Simple Page
find average of all relative for each period.
Average of 19.5
Drawback: It gives equal importance to each of the
Relatives
relatives
Laspeyres’ Σ𝑃 𝑄
× 100
Methods/ Index Σ𝑃 𝑄
Formulas for
Index Paasche’s Σ𝑃 𝑄
× 100
Numbers Index Σ𝑃 𝑄
Weighted Marshall-
Aggregative Σ𝑃 (𝑄 + 𝑄 )
Edgeworth × 100
Index Index Σ𝑃 (𝑄 + 𝑄 )
Σ𝑃 𝑄 Σ𝑃 𝑄
× × 100
Fisher’s ideal Σ𝑃 𝑄 Σ𝑃 𝑄
Price Index
(GM of Laspeyres’ and
Paasche’s)

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 CA Foundation – Mathematics, Stats and LR | Revision Notes | Index Number

Weighted Page
Average of ∑ × (𝑃 𝑄 ) 19.7
Relative × 100 Example
Σ𝑃 𝑄
Method
Page
Chain Index
Chain Index 19.8
Numbers Link relative of current year × Chain Index of previous year Example
=
100

Quantity Though price indices are widely used to measure the

Index economic strength, Quantity indices are used as
Numbers indicators of the level of output in economy.

value index equals the total sum of the values of a given

Value year divided by the sum of the values of the base year
Indices Σ𝑉 Σ𝑃 𝑄
=
Σ𝑉 Σ𝑃 𝑄

Limitations of → Chances of errors due to Sampling

Index → It gives broad trend not real picture (as it is based on sample)
Numbers → Due to many methods, at times it creates confusion
→ Framing suitable policies in economics and business
Usefulness of → They reveal trends and tendencies in making important conclusions
Index → They are used in time series analysis to study long-term trend, seasonal
Numbers variations and cyclical developments
→ Index numbers are very useful in deflating (eg. Nominal wages into real)
Deflated Current Value
De lated Value =
Value Price Index of the current year
Shifting Price Original Price Index
Shifted Price Index = × 100
Index Price Index of the year on which it has to be shifted
Splicing Two
Useful when there is new method of calculation or the inclusion of new commodity in index.
Index Series
Unit Test Formula should be independent of unit. All except simple aggregative
index satisfy this test
Time Reversal → It is a test to determine whether a given method will work both
Test ways in time, forward and backward.
→ Two indices should be reciprocals of each other
→ 𝑃 ×𝑃 = 1
→ Laspeyres’ method and Paasche’s method do not satisfy this
test, but Fisher’s Ideal Formula does
Factor → This holds when the product of price index and the quantity
Reversal Test index should be equal to the corresponding value index
Test of → 𝑃 ×𝑄 =𝑉
Adequacy → Only Fisher’s Index satisfies Factor Reversal test
→ Fisher’s Index Number is ideal as it satisfies Unit, Time
Reversal and Factor Reversal Test
Circular Test → This property therefore enables us to adjust the index values
from period to period without referring each time to the
original base. The test of this shift ability of base is called the
circular test.
→ This test is not met by Laspeyres, or Paasche’s or the Fisher’s
ideal index.
→ The simple geometric mean of price relatives and the weighted
aggregative with fixed weights meet this test

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