Index Number-Meaning and Concept

• An index number is a statistical device used to measure the changes in the related variables. It acts as a tool for
analysing the changes in the variables during a given period of time.
• The first index was constructed by Carli in 1764 to compare the Italian price index in 1750 with the price level in 1500.
• Originally, index number was developed for measuring the effect of change in prices, but now a days it is used as
barometer of economic activity, such as index number of industrial production, agricultural production, business
activity, etc.
• Index numbers are used to measure the relative change in the level of a variable or group of variables with respect to
time, geographical location etc.
• In other words, these are the numbers which express the value of a variable at any given period called ―the current
period ―as a percentage of the value of that variable at some standard period called ―the base period.
• Index numbers are a specialised type of rates, ratios and percentages.
 Basic Features of Index Numbers

(i) Relative measurement: Index number helps in analysing the changes in the variable with reference to a base year. Base
year refers to that year against which the values of the variable in the current year (such as price, wages, and quantity) are
compared. In this sense, it helps in the relative analysis (that is, comparison) of the changes in the values of the variable.
 Basic Features of Index Numbers

(i) Relative measurement: Index number helps in analysing the changes in the variable with reference to a base year. Base
year refers to that year against which the values of the variable in the current year (such as price, wages, and quantity) are
compared. In this sense, it helps in the relative analysis (that is, comparison) of the changes in the values of the variable.

(ii) Expressed in percentage: Index numbers express the changes in the variables in terms of percentage. For example,
suppose the index of the output in the year 2009 is 150 as compared to 100 in the year 2000. This suggests that compared
to the year 2000, the output has risen by 50% in the year 2009.
 Basic Features of Index Numbers

(i) Relative measurement: Index number helps in analysing the changes in the variable with reference to a base year. Base
year refers to that year against which the values of the variable in the current year (such as price, wages, and quantity) are
compared. In this sense, it helps in the relative analysis (that is, comparison) of the changes in the values of the variable.

(ii) Expressed in percentage: Index numbers express the changes in the variables in terms of percentage. For example,
suppose the index of the output in the year 2009 is 150 as compared to 100 in the year 2000. This suggests that compared
to the year 2000, the output has risen by 50% in the year 2009.

(iii) Specialized average : With the help of index number, the two series which are in different units can also be
compared. Thus, index number are a specialized average.
 Basic Features of Index Numbers

(i) Relative measurement: Index number helps in analysing the changes in the variable with reference to a base year. Base
year refers to that year against which the values of the variable in the current year (such as price, wages, and quantity) are
compared. In this sense, it helps in the relative analysis (that is, comparison) of the changes in the values of the variable.

(ii) Expressed in percentage: Index numbers express the changes in the variables in terms of percentage. For example,
suppose the index of the output in the year 2009 is 150 as compared to 100 in the year 2000. This suggests that compared
to the year 2000, the output has risen by 50% in the year 2009.

(iii) Specialized average : With the help of index number, the two series which are in different units can also be
compared. Thus, index number are a specialized average.

(iv) Measures change in absolute quantitative terms : Index numbers helps in estimating the absolute quantitative
changes in the variables. For example, if the price index is 120 in 2008 as compared to 100 in 2004 then, this suggests that
the price has risen by 20%.
 Difficulties in the Construction of Index Numbers

1. Objective : Different index numbers serve different objectives. Based on the purpose of the study, an appropriate index
number must be chosen. For example, in order to study the relative change in the quantities, we prepare a quantity index.
Similarly, if the objective is to study the changes in the cost of living, we construct a consumer price Index.

2. Base period selection : Base year refers to that year against which the values of the variable in the current year (such as
price, wages, quantity) are compared. The base year acts as the reference year for analysing the changes in the variable.
While selecting a base year, the following points must be remembered.
i. Should neither be too long nor too short: The base year should not be less than a month nor longer than a year.
ii. Should be neither too far nor too near : The base year should be either too close or too far from the current year. If
the difference in the base year and the current year is not appropriate, then the comparison becomes difficult. Too far
a base year would not serve the purpose of comparison.
iii. Should be a normal year : The base period should also be normal and free from any kind of abnormalities and
fluctuations such as natural calamities, business cycles (booms and depressions).
 Difficulties in the Construction of Index Numbers

3. Item selection : The selection of items must be based on the following points.
i. The items selected should be a representative of the entire group.
ii. The number of items selected should be neither too large nor too few. If, the number of items is too small, then the data
might not be a true representative of the entire group. On the other hand, too many items makes the calculation tedious
and lengthy.
4. Reliable source of data : For the construction of suitable index numbers, the source from which the data is collected
plays a crucial role. The data must be collected from a reliable source so that it is accurate and representative.
5. Choice of an average : Index number involves use of any average such as mean, median or mode. However, median
and mode are found unsuitable for deriving meaningful conclusions.
6. Suitable weightage system : Various items in the index are assigned weights as per their importance. These weights
reflect the relative importance of the item in the index. It is necessary to assign suitable weights to different items in the
index.
 Difficulties in the Construction of Index Numbers

7. Type of Average to be used: The commonly used averages so used in Index number construction are AM, GM and
Median. Out of these three, median is the easiest to calculate and since median is more affected by the middle terms so
median is rarely used. Thus, the only choice is to be made is between AM or GM. Both can lead to different values of
index numbers. Theoretically, GM is the most appropriate average in case of Index number constructions:
a. GM gives equal weights to equal ratio of change. For instance, if the price of a good is doubled while the price of
another good is halved, then GM is not affected, whereas, AM will show a rise by 1/4th.
b. Secondly, GM accords more importance to smaller items and lesser importance to large items.
c. Index number based on GM are reversible (as per Time Reversal Test)
Thus, use of GM leads to higher precision and accuracy in Index number, but since GM has computational difficulties, so
AM is generally preferred to GM.
 Categories of Index Numbers

Simple Index Numbers : It refers to those index numbers, in which all the
items of the series are assigned equal weightage or equal importance. For
example, in a simple price index, all the items included in the index are
accorded equal weightage.
Weighted Index Numbers : It refers to those index numbers in which
different items of the series are accorded different weights depending on
their relative importance. For example, if a weighted price index is
constructed, then different items will be accorded different weights based
on their relative importance. The importance of the items in the index can
be judged on various grounds, say on the basis of the expenditure incurred
on it. The item on which the highest expenditure is incurred is assigned the
highest weight in the index. Similarly, weights are assigned to other items.
 Simple Index Numbers
(i) Simple aggregative method
According to this method, for the construction of
index number, the aggregate of the current year
prices (or quantities) are divided by the aggregate
of the base year prices (or quantities) and the
result is multiplied by 100.
 Simple Index Numbers
(i) Simple aggregative method
According to this method, for the construction of
index number, the aggregate of the current year
prices (or quantities) are divided by the aggregate
of the base year prices (or quantities) and the
result is multiplied by 100.
Simple Index Numbers
 Weighted Index Numbers

Weighted index numbers can be calculated using the following two methods.
(i) Weighted Average of Price Relative Method
(ii) Weighted Aggregative Method
(i) Weighted average of price relatives method
According to this method, we first calculate the weighted price relative of each
item (that is, price relative multiplied by the weight). Then the aggregate of the
weighted price relative is divided by the aggregate of the weights. That is
 Weighted Index Numbers
(ii) Weighted aggregative method
Under this method, weights are assigned to different items based on the quantities bought of the
items.
Laspeyre's Price Index Number :
In Laspeyre's Price Index Number, base year quantities are treated as weights.
p 1 refers to current year prices
p 0 refers to base year prices
Paasche's Price Index Number q 0 refers to base year quantities
It is calculated by taking current year quantities as weights.
p 1 refers to current year price
p 0 refers to base year prices
q 1 refers to current quantities
Fisher's Price Index Number
Fisher's Price Index Number considers both current year as well as base year quantities as weights.

p 0 refers to base year prices

p 1 refers to current year prices
q 0 refers to base year quantities
q 1 refers to current year quantities
Weighted Index Numbers
 Weighted Index Numbers
Since it involves Laspreye’s (upward bias) and Paasche’s price index (downward bias), so M-E price index is free from any
bias. Thus, it provide a better estimate of true price index. The value of ME lie between Laspreye’s and Paasche’s index. It
is an ideal index, as it satisfies Time Reversal and Factor Reversal Test, but it is rarely used in real life due to complex
calculations

Fisher's Price Index Number

Fisher's Price Index Number considers both current year as well as base year quantities as weights.
p 0 refers to base year prices
p 1 refers to current year prices
q 0 refers to base year quantities
q 1 refers to current year quantities
 Weighted Index Numbers
Since it involves Laspreye’s (upward bias) and Paasche’s price index (downward bias), so M-E price index is free from any
bias. Thus, it provide a better estimate of true price index. The value of ME lie between Laspreye’s and Paasche’s index. It
is an ideal index, as it satisfies Time Reversal and Factor Reversal Test, but it is rarely used in real life due to complex
calculations

Fisher's Price Index Number

Fisher's Price Index Number considers both current year as well as base year quantities as weights.
p 0 refers to base year prices
p 1 refers to current year prices
q 0 refers to base year quantities
q 1 refers to current year quantities
Weighted Index Numbers
Weighted Index Numbers
Quantity Index Numbers
 Consistency Tests of Index Number

These consistency tests help us to decide the criteria for

a good index number

* If Laspeyre’s price index is equal to Paasche’s price

index, then both of these index numbers satisfy the time
reversal test and factor reversal test.
Base Shifting
Base Shifting
Base Shifting
Deflating
Questions
Questions