| ! Index Numbers—q —————————— B INTRODUCTION me 7 i t of index number, the problems in j In the previous chapter, we have studied the concept jex nm sini battens ‘methods of constructing them and the tests of an ideal index number. During the process of index numbers’ construction, some specific problems like construction of chain index, base shifting, splicing, deflating, construction ofa consumer price index, etc., come across us, Itig very essential to take them properly into consideration. Here below, we will study such specific problems: Specific Problems Regarding Construction of Index Numbers Consumer Chain Base e bese Chain ase Splicing Defiating Price Index & Fed |) conversion siting ian 1 CHAIN BASE AND FIXED BASE INDEX © Chain Base Index (CBI) Chain base index is that index number in which the year immediately proceeding the one is taken as base year. For example, suppose, we want to construct index numbers for 1990, 91, 92, 93 and we take 1990 as base for 1991, 1991 as base year for 1992 and 1992 as base for 1993, then such type of index is called chain base index. © Steps in Construction of Chain Base Index @ First of all, link relatives are computed using the following formula: Link Relative = Current Year’s Price Previous Year’s Price (ii) The link relatives are then converted into chain base index using the following formula: Chain Base Index = Link Relatives of Current Yearx Chain Index of Previous Year 100 The construction of chain indices can be illustrated with the following examples: © Single Commodity Case Example 1, Calculate Chain Base Index from the following data: Year: 2005 - 2006 2007 2008 2009 2010 5 ©: ba! 98 102 95 98 100 x 100Tink Relatives: Computation of CBI [rnces_] (ros se 1 [Ginter tages 104.3 x100 100 = 1043 104.1% 104.3 93.1% 108.6 100 =10L1 103.2x1011 109 = 1043 102 x104.3 109 7 1064 Computation of CBI | se” ee E fia asl Sears 2008 100 2010 105 a | 2012 175 Ti5*9975 79 og j 2013 102 | @ Multi Commodity Case tumple3. Compute Chain Base Index for the following data: | 200 sl u ap 0 | i 2 3 4 0 8 i0 2 a 4 5 8 Computation of Chain Base Index Chained to 2010 "20 Group of 2010 ie. Commodities |p [re] fae | 2 | 100 Ly 8 _| 100 mm 4 | 100Total | 300 400 ‘Average of LR. 100 133.33 Chain Base Indox 100 133.33 x10 i FIXED BASE INDEX (FBI) In fixed base index, the base year remains fixed. Fixed Base Index is an index in which ty years the fixed year. For example, suppose, we want to construct indices for 1990, 91 a ase 7 592, take 1990 alone as base year for all the years, then such type of index is calledas fixed hace © Steps in Construction of Fixed Base Index Fixed base index is computed in the following manner: (i) First of all, any normal year or period is taken as base year. When there is a difficulty selecting a particular year as base year, then the average price of few years is taken as base ve a (ji) Then the price relatives are found out using the following formula: a: Price Retative = CUrTEMt Year's Price , 199 Base Year's Price (iii) Hit is a single commodity case, then these price relatives would be FBIs. But ifitisa multi-commodity case, then by summing up the price relative for each year and dividin the sum by the number of commodity, average of price relatives are found out, These averages are fixed base indices, The method of constructing fixed base index is illustrated by the following examples: © Single Commodity Case Example 4. Calculate index numbers for the following data by taking (a) price of 2005 as base and (b) average of all the prices as base. 2005 | 2006 | 2007 | 2008 | 2009 | 200 | 201 | 22 110 120 160 150 180 200 220 210 Solution: Calculation of FBI [Brice [index No, (005 =100) [ Index Nov (Base =16815)| 110 100. 10 400=652 168.75 2006 ae 120 100= 109.1 20_ 5100-114 0 168.75 2007 160 100 100-1455 160 100-948 110 168.75 2008 150 150. ion=i364 450-100 =889 110 168.75 2009 180 180 180 SS 100= 163, (1) Aggregate Expenditure Method In this method, weights ae assigned to items on the basis of base year quantities (q z ° Consumer Price Index ( P,,)=—149 5.109 = Pod is Note: Aggregative expenditure method is the same as Laspeyre’s Method, Steps for Calculation © Quantity in base year (7,) and prices in current year (p,) are multiplied and their sum © p,4,) is taken. This is the aggregate expenditure in curtent year. G2 Quantity in base year (q,) and price in base year (p,) are multiplied and their sum (@ >a) is taken, This is the aggregate expenditure in base year. (i © p,q,is divided by p,g,and the quotient is multiplied by 100. > (2) Family Budget Method Under this method, the weights are assigned to items on the basis of percentage expenditure on the items. " l Pw Consumer Price Index ( P,,) Seta ‘ Where, P = Price Relatives = 1 100, W = Total Expenses in the base year= Po Ie Ie the geometric mean is used, then P, =ai{ BoB Family budget method is nothing but Weighted Average of Price Relative Method. Steps for Calculation @ Price relative of current year for each commodity is computed by the following formula: P =P x 109 Py i) Price relative of each commodity is multiplied by the expenditure oa it or (Value Weight or W) to find out weighted price relatives, re,yrs oe est pioniiiet wyamutulde a “ Weighted price relatives are summed up (pW) (a) 2, Ze summation of weights which is p,q: obtined 0) pW is divided by EW and the quotient is multiplied by 100, : ld be noted that pri * Note Lit should 2 Prices and ‘quantities i *. plying. I'units of price and quantity are different, then the aaa be same in units while a ere nit of price before carrying out multiplicati ifthe nalY must be changed f ite Wy purchased in kg. then kgs. must be inal betes imal a “ey we cation. Mintals before carrying out m —_ Nae 2 The consumer price index number (or cost of living index) oblaned by both the aethods is the same. Note3: Aggregate expenditure method should alway, ion. For example, converted into s be preferred to in as much teeaier than the family budget method so far as calculations are concerned, ‘Stemi u 6 When units of price and quantity are the same | gsample25. From the following data, find the Cost of Living Index number ‘of 2015 on the basis of ce 2010 by (#) Agaregate Expenditure Method; and (i) Family Budget Method, | Items Quantity consumed | ~~ wo z cee in 2010 fem | 2. Qtls fy) Rice 20Kg a Sugar 10Kg Kg 2 L 16 | Ghee sKg Kg 10 15 | Clothing ea 25 Meters Meter 45 5 10 2 ra |_ Fuel 40Kg kg Rent ‘One House House 25 40 Solution: Construction of Cost of Living Index Number by Aggregative Expenditure Method Items Quantity Unit | Prices in || Pricesin Prt Pity tg consumed in 2010 (4) [Wheat Rice 20Kg Kg 12 = Sugar | 10Kg Kg 12 = Clothing | 25 Meters [| Fuel 40 Kg [ «| F] [Rent | One House |ee ee ee 728 Statistical Methods for Economicg 214. 1450 Cost of Living Index Number (P,, ie +1002 *100> 132.12 ({i) Computation of Cost of Living Index Number by Family Budget Method Pytems ||) Quantity |! Unit |)Pricesin | Pricesin | Price use » {292010 | 2015(p,) | | relatives Kg 2 16 133.33, 240 | 319992 133.33 120 Kg 12 16 159996 150. 50 kg | 10 15 50.00 7500 Clothing] 25Meters | Meter | 45 3 uit} 2s | 12499875 Fuel 40 Ke Kg 10 12 120.00 400 48000 Rent | OneHouse | House | 25 40 160.00 25 4000 mw Pw =1097.5 |=144997.675 44997 .675 Cost of Living Index(P,, )= =P = 144997-675_ 135 19 EW 1097.5 © When units of price and quantity are different Example 26. Construct Cost of Living Index Number of 2000 on the basis of 1990 by (i) Aggregate Expenditure Method, and (ii) Family Budget Method: Ttems - Quantity consumed | — ahs test hg i Wheat 2Qts Qs Rice 1Q4 Qts Athar 20Kg Kg 1.20 2.80 Sugar 0.5 Qs. Kg 2.0 3.00 Salt 10Kg Qts 20 30 Oil 10Kg Kg 7] 4 | a Clothing 20 Meter Meter 3 5 Fuel 408 Qts 12 15 Rent One House House 50 75 Solution: Since the unit of price and quantity of two items such as sugar and salt are different, we should convert the unit of quantity into the unit of price before we apply any method.yds @ Construction of Cost of Living Index by Aggregate Expenditu: Items Quantity Unit | Price in e re Dethed consumed Price in in, 1990.(g9) 2 Qts 1 7 20Kg wm = [Sugar 50Kg Ke ate om [sate 0.1QtIs. B " oil 10Kg 8 ” a Clothing _| 20 Meter = eo 7 Fuel 6 ane a e= One ass 75 =i me cay { pga = 504] p14 = 834 Cost of Living Index Number (Py, > 5 @ Construction of Cost of, ile Index by Family Budget method Items | Quantity | Unit }- Pr consumed i in 1990 2Pifo 100 00 aot x 100=165.47 =165.5 504 feel: W=r% Pw Wheat | 2 Qts 100 200 Qts Rice _| 1Qt Qs Asbar | 20Kg | Ke Sugar_| 50Kg salt | 0.10 Qts. oil 10Kg. Clothing} 20 meter Fuet__| 4Qts. ute 83400_ 165.5 Cost of Living Index Number (Py) = S04Prices of the commodities have gone up by 32.12% © When prices and weights are given Example 28. Calculate cost of living index for the year 2017 from the following data using family budget method:ve & yee gine group weighs ae directly given slong withthe rics in 0 mH base year and current year we frst determine the price relatives and then multiply it with ith weight, Construction of CPI Food Rent Clothing DPW _13862.5- =W Interpretation: It shows that the cost of living has gone up by 38.63% in current year as compared to base year. CPI 138.625 | © When group indices and weights are given. Example 29. The following table gives the index number for different groups together with their ights for 2000 (base year = 1995) aa Food 130 60 Clothing 280 3 Lighteing and Fuel 190 i 1 Rent 300 9 Miscellaneous 200 L 19 Find the overall cost of living index number for the year 2000 using family budget method, Suppose a person was earning © 18,000 in 1995, what should be his salary in 2000 if his standard of living in that year is to be the same as in 1995. Since group weights and group index (price relatives) are directly given, we multiply indices group with the weights (W). Construction of Cost of 1400, Rent Miscellaneous —_l| 732 Statistical Methods eee em , 8 f0F Economic, | EIW _ 1703 P= oar = = 170.30 EW 100 (ii) Now to find the salary ofthe person in the year 2000 when his salary in 1995 was ©18,000, we proceed as follows: Old Salary in 1995 _New Salary in 2000 Old Index New Index 18,000 _ New Salary in 2000 100 170.30 . 18,000 ‘New Sal 2000 = lew Salary in 700 = % 30654 The person should get ® 30654 for maintaining the same standard of living as in 1995, IMPORTANT TYPICAL EXAMPLES BASED ON FAMILY BUDGET METHOD Example 30. Calculate Price Index number for 2013 taking 2009 as base from the following data relating to cost of living of the working class in a city. What is the change in the cost of living figure in 2013 as compared to 2009? There was a wage increase of 20% from 2009 to 2013. Is it adequate? * 170.30 Solution: Here the percentage expenses on different items are given and these will be taken as weights: Construction of Cost of Living Index748 Statistical Methods, {or Econo Suppose the rise in cost is proportion to index. Cost in 2001 ~02 = Cost in 1995-96 os Cost inflation index number in 2001-02 Cost inflation index number in 1998-3: Index number in 2001 ~ 9 5~96 Index number in 1995 ~9¢ 426 = 50,000 x =° = 875,800, a 00.71 Solution: <. Indexed cost in 2001-02 = Cost in 1995-96 x Capital gain = Sale Price — Indexed cost = 1,50,000 75,800.71 = %74,199.29 Apparent gain = Sale price ~ Purchase price = 1,50,000 — 50,000 =%1,00,000 ‘Thus, the apparent gain is €1,00,000; however, taking to account inflation the ga; we real sense is 774,199.29. For tax calculations, real capital gain is used. ain in IMPORTANT FORMULAE Chain Base Index = A¥2T282 Of LR of Current year pel Base Index of Previous ye 1. Chain Base Index: 2. Conversion of Chain Base Index to Fixed Base Index: Fixed Base Index = Coren year's CB 1 Previous years. 3. Conversion of Fixed Base Index to Chain Base Index: Current Year's FBI x100 Chain Base Index Number =" Previous Year's FDI 4, Base Shifting: New Index Number =! Index Number ofthe Curent year pg Old Index Number of the New year 5, Splicing of Index Numbers: Spliced Index Number _— Index Number of Current yearx Old Index Number of New Base year 100 6. Deflating of Index Number: Real Income = Miiney lncoine 1 Cost of Living Index NumberH ee ye 749 Cost of Tiving Index Numbers/Consumer’s Price Index “ ragaregative Expenditure Method: ( : y Consumer Price Index = Pio 100 049 get Method: PW =W (i When Group Indices and Weights are given: lw Consumer Price Index = ——— LW (@ Family Buds Consumer Price Index = 1| quesTIONS. Distinguish between fixed base and chain base methods of constructing index number and give their relative merits. Write a short note on ‘Chain Base Index’. Explain the following terms: (/) Base Shifting (i) Splicing and (ii) Deflating. What isthe cost of living index number? Discuss its uses. Give formulae you will use in the construction of cost of living index. Discuss the uses and construction of Consumer Price Index. Using suitable examples, explain the operations of base shifting, context of index numbers. Explain the purpose of base shifting, splicing and deflating of index number with suitable examples. iving Index. 8 Explain the methods of constructing cost of | heros splicing and deflating in the a