1.

Meaning
2. Definition
3. Features
4. Steps or problems in the construction of
Index Numbers
5. Notations used in Index Numbers
6. Types of index numbers
7. Methods of Constructing Index Numbers
8. Tests for ideal Index Numbers
9. Uses of Index Numbers
10. Limitations of Index Numbers
 It is a statistics which assigns a
single number to several individuals statistics in
order to quantify trends. Two or more time
periods are involved, one of which is the base
time period.
 In other words, Index numbers is a statistical
tool for measuring relative change in a group
of related variables over two or more
different times.
 Index numbers measure relative changes in the
price of a sum of representative data.
 Index Numbers are expressed in percentage.
 An Index time series is a list of
index numbers for two or more periods of
time, where each Index Numbers employs the
same base years.
 According to Maslow, “It is a numerical value
characterizing the change in complex economic
phenomena over a period of time or space.”
 According to John Rriffin, “Index Numbers are
used to measure changes over time in magnitudes
which are not capable of direct measurement.”
 In the words of Tuttle, “ An index number is a
single ratio (usually in percentage)which measures
the combined (i.e., averaged) change of several
variables between two different times, places or
situations.”
 In the words of Edge worth, “Index number shows
by its variation the changes in a magnitude which
is not susceptible either of a accurate
measurement in itself or of direct valuation in
practice.”
 They are expressed in percentages.
 They are special types of averages.
 They measure the effect of change over a
period of time.
1. Defining the purpose of index numbers
2. Selection of items
3. Selection of base period
4. Selection of prices
5. Selection of weights
6. Choice of an average
7. Choice of the formulae
 Basis Narration
Base year The year selected for the comparison
Current The year for which comparison are sought
year
P0 Price of commodity in the Base year
P1 Price of commodity in the current year
Q0 Quantity of a commodity consumed or purchased
during the Base year
Q1 Quantity of a commodity consumed or purchased
during the Current year
W Weight assigned to a commodity according to its
relative importance in the group
 Basis Narration
P01 Price Index Number for the Base year with
reference to the Current year
P10 Price Index Number for the Current year with
reference to the Base year
Q01 Quantity Index Number for the Base year with
reference to the Current year
Q10 Quantity Index Number for the Current year with
reference to the Base year
Price(quantity The Prices(Quantity) corresponding to different
) time periods with expressed as ratios to the Base
Relatives year Prices(Quantity) as Price(Quantity) relative
Like P1/Po, P2/P0, P3/P0
Q1/Q0, Q2/Q0, Q3/Q0
1. Price Index Numbers
2. Quantity Index Numbers
3. Value Index Numbers
4. Simple Index Numbers
5. Composite Index Numbers
6. Cost of Living Index Numbers
 Price Index Numbers are
most popular and commonly used Index
Numbers. These Index Numbers measure the
change in price of some commodities or group of
commodities consumed in the given period with
reference to the Base period.
 There are two types:
1. Whole sale Price Index: It measures the
change in general price level of
commodity.
2. Retail Price Index: It measures the general
changes in retail price of commodities.
Construction of Price Index Number
This Compares the prices
of group of commodities at a certain time or
place with of Base period or place
respectively.
 The Simplest Formula for calculating Price
Index Number is given by:
P01= P1 X 100
P0
 Quantity Index Numbers helps
us in measuring and comparing the changes in
the physical volume of goods produced or
sold or purchased in given amount of year.
 Construction of Quantity Index
Number
This Index Number measures
the changes in the level of quantities of items
consumed or produced or distributed during a
year under the study with reference to Base
year.
 The Simplest Formula for calculating Quantity
Index Number is given by:
Q01= Q1 X 100
Q0
 Value Index Numbers
measure the changes in the value of some
commodities or group of commodities consumed
or purchased in the given period with
reference to base year.
 It is also known as Volume Index Numbers.
 Construction of Value Index
Number
 This compares the total value of some period
with the total value of base periods.
 This Index Number measures the change in the
level of value of items consumed during the
current year with reference to the value of
items consumed in the base year .
 The Simplest Formula for calculating Value Index
Number is given by:
V01= V1 X 100
V0
V1 X 100 = P1Q1 x 100
V0 PoQo
 A Simple Index Number
measures the changes in price or quantity of
a single item over time.
• It is calculated by dividing the current year
value by the base year value and then
multiplying the result by 100.
 Construction of Simple Index
Number
 Steps:
1. Obtain the prices or quantities for
the commodity over the time period of
interest.
2. Select the period used to be as base.
3. Divide current year price(P1) of the
commodity by the base year(P0).
4. Multiply this ratio by 100.
5. Price Index (IP)= P1 X 100
P0
6. Quantity Index (Iq)= Q1 x 100
Q0
 The composite index number is a
weighted mean of the elementary index
numbers in which the weighting represents the
"mass" of the elementary numbers(in the case of
price indices, this mass is expenditure).
 In Other words, A composite index number
measures the variation in the value of a
composite number defined as the aggregate of a
set of elementary numbers
 For example, the consumer price index measures
the variation in the prices of 1,000 varieties of
products in a single index number
 1. Simple (Unweighted)
2. weighted Index Numbers
Index
Numbers
(a)Simple Aggregative (a) Simple Average of Price
Method (b) Weighted Average of
(b) Simple Average of Price Price
Relatives Method Relatives Method
 A simple arithmetic or geometric
average used to calculate stock indexes.
 Equal weight is invested in each of
the stocks in an index with equal dollar
amounts invested in each underlying stock.
 Because the stocks are equally weighted,
one stock's performance will not have a
dramatic effect on the performance of the
index as a whole.
 This differs from weighted indexes, where
some stocks are given more weight than
others, usually based on their
market capitalizations.
1. Simple Aggregative 2. Simple Average of
Method Price
Relatives Method
 This is the simplest method of
constructing index numbers. In this method,
aggregate prices of all the selected
commodities in the current year are divided by
the aggregate prices in the base year and
Multiplied by 100 to get Index.
 Steps Involved in the
constructions of Simple
Aggregative Method
1. Add up the current year prices of various
commodities and denote by P1 .
2. Add up the base year prices of various
commodities  P0 .
3. Use the following formula:
P01= P1 X 100
 P0
 This index is an
improvement over the simple aggregative price
index because it is not affected by the unit
in which prices are quoted.
 One way to rectify the drawbacks of a simple
aggregate index is to construct a simple
average of relatives.
 Price relative: A price relative is percentage
ratio between price of commodity in the
current year and that in the base year
 Constructions of Simple Average
Of Price relative Method
 In this method the price relative of each
item is calculated .
 Price Index number of the Current year find
out by using the following formula :
P01 =  P1 x 100
P0
N
N = Number of
goods
Price relative = P1 x
100
 When all commodities are not of equal
importance. We assign weight to each
commodity relative to its importance and index
number computed from these weights is called
weighted index numbers.
 1.Weighted Aggregative 2.Weighted Average
Method of
Relatives Method

Laspeyre’s Paasche’s Fisher’s IdealDorbish & Bowley’s Marshal- Kelley's

Method Method Method Method Edgeworth Method
Method
 Under this method we weight
the price of each commodity by a suitable factor
often taken as the quantity or value weight sold
during the base year or the given year or an average
of some years.
 The choice of one or the other will depend on the
importance we want to give to a period besides the
quantity used.
 The various alternative formula's in use are:
1. Laspeyer’s Method
2. Paasche’s Method
3. Fisher’s Ideal Method
4. Dorbish & Bowley’s Method
5. Marshall-Edgeworth Method
 Laspeyer’s Method
The Laspeyre's Price
Index is a weighted aggregate price index, where
the weights are determined by quantities in the
base period. The distinctive feature of the
Laspeyre's index is that it uses a group of
commodities purchased in the base period as the
comparison.
 Mr. Laspeyre's in 1871 constructed this method.
Steps:
1. Multiply the current year prices (P1) by
base year quantity weights (Q0) and total
all such products to get  P1Q0.
2. Similarly, Multiply the base year prices (P0)
by base year quantity weights (Q0) and
obtain the total to get  P0Q0.
3. Divided  P1Q0 by  PoQo and multiply the
quotient by 100. This will be the index number
of the current year.
Formula: P01 =  P1Q0 x 100
 P0Q0
 Paache’s Method
The German
statistician Paasche in 1874 constructed an
index number, in which weights are
determined by quantities in the given year. It
helps in answering the question that, if the
current period basket of commodities was
consumed in the base period and if we were
spending Rs 100 on it, how should be the
expenditure in current period on the same
basket of commodities.
Steps:
1. Multiply the current year prices (P1) by
current year quantities (Q1) and total all such
products to get P Q1 1 .
2. Similarly , multiply the base year prices (P0)
by current year quantities (Q1)and obtain the
total to get PQ0 1 .
3. Divide  P1Q1 by  P0Q1 and multiply the quotient
by 100. This will be the index number of the
current year.
Formula: P01 =  P1Q1 x 100
 P0Q1
 Fisher’s Ideal Method
Fisher has combined
the techniques of Laspeyres and Paasches
Method. He used both base year as well
as Current Year quantities (Q0, Q1) as
weight. Prof. Irving fisher has given a
number of formulae for constructing index
numbers and of these, he calls one as the
‘ideal’ index.
Formula:
P01 =  P1Q0  P1Q1
100
 P0Q0  P0Q1
 Fisher’s Method is considered as
ideal Method because:
1. It is based on variable weights.
2. It takes into consideration the price and
quantities of both the base year and
current year.
3. It is based on geometric mean which is
regarded as best mean for calculating Index
number.
4. It satisfies both the time reversal test and
Factor reversal test.
 Dorbish & Bowley’s Method
 Dorbish and Bowley have suggested simple
arithmetic mean of the two indices
(Laspeyre’s and Paasche’s) mentioned above
so s to take into account the influence of
both the periods, i.e., current as well as
base periods. The formula for constructing
the Index is:
P01 = L + P
2
Where , L = Laspyre’s Index, P = Paasche’s
Index
Formula:
 Marshall - Edgeworth Method
The
formula enunciated by Marshall and
Edgeworth for constructing an index number
is known as Marshall-Edge worth’s method.
In this method, they have suggested to take
the arithmetic average of the quantities of
the quantities of the base year, and the
current year as the weights of the items.
 In this method, the current year as well as
the base year prices are considered.
Formula:
P01=  (Q0+Q1) P1 X 100
 (Q0+Q1) P0

P01 =  P1Q0 +  P1Q1 x

100
 P0Q0 +  P0Q1
 Kelley's Method
In this method,
weights are the quantities which may refer to
some period, not necessarily the base year or
current year. Thus the average quantity of
two or more years may be used as weights.
 This Method was given by Truman L. Kelly.
Formula:
 It Can be classified into two types:
1. Weighted Average of Price Relatives
Method
2. Weighted Average of Quantity
Relatives Method
 Weighted Average of Price
Relatives Method
Weighted average of price
relative’s index is obtained by multiplying the
relatives with the weights assigned to each
commodity and then summing these products
year by year finally dividing the totals for
each year by sum of the weights.
Formula :
P01 = S PV
SV Where, V= Value Weight
(P0Q0)
P= Price Relative = P1 x
100

P0
Steps:
1. Find the price relatives for each
commodity.
2. Multiply the price relatives with their
corresponding weights to get PV.
3. Obtain the sum of products for all
commodities to get SPV.
4. Divide the sum by SV
Weighted Average of Quantity
Relatives Methods
The formula for computing a
weighted average of quantity relative index is also
same as used to compute a price index.
Formula : S QV
S V Where V = Value
Weight(Q0P0)
Q= Quantity Relative= Q1
x 100

Q0
Steps:
1. Find the quantity relatives for each
commodity.
2. Multiply the Quantity relatives with
their corresponding weights to get PV.
3. Obtain the sum of products for all
commodities to get SQV.
4. Divide the sum by SV
 Consumer price Index is also known
as Cost of Living index or Price of Living Index. It
represents the average change over time in the
prices paid by the ultimate consumer of a specified
basket of goods & services.
 A change in price affects the cost of living of
different classes of people differently.
 The general Index numbers fails to reveal this.
So there is a need to construct consumer price
Index.
 Peoples consumption habits are also different
from man to man, place to place and class to
class. Like rich class or poor class etc
Objectives of Consumer Price Index:
1. To measure the impact of ‘price’ change on the purchasing power of the
after tax money incomes of wage & salary earner households.
2. Its main objective is to track inflation.
3. Its focus remains on controlling inflation with the help of monetary
policies to take decisions.
 Steps:
1. Decide the class of people for whom Index numbers is intended.
2. Conduct ‘family budget enquiry’ in the base period relating to the class of people
concerned.
3. Items of expenditure to be classified.
4. Price quotation to be taken.
5. For each item there will be a number of Price quotations covering different
qualities and markets. The simple average of price relatives of different quotations
is taken as the price relative for the particular item.
6. A separate Index is computed for each group
Group Index (I) = S W Pn X 100
P0
100
Where, W = P0Q0 X 100
S POQO
7. The weighted average group index numbers gives the
Final Consumer Index Number.
Consumer Index = S IW
100
100
1. Aggregate Expenditure Method 2. Family Budget Metho
 This method is similar to the
Laspeyre’s method of constructing weighted
index. To apply this method, the quantities of
commodities by the particular group in the base
year are estimated and these figures are used
as weights. Then, the total expenditure on
each commodity for each year (base and
current) are calculated.
Formula:
CPI =  P1Q0 x
100
 P0Q0
Steps:
1. Similarly, Multiply the base year prices (P0)
by base year quantity weights (Q0) and
obtain the total to get  P0Q0.
2. Multiply the current year prices (P1) by
base year quantity weights (Q0) and total
all such products to get  P1Q0.
3. Divided  P1Q0 by  PoQo and multiply the
quotient by 100. This will be the consumer
price index number.
Formula: CPI=  P1Q0 x 100
 P0Q0
 In this method, the
family budgets of a large number of people,
for whom the index is meant, are carefully
studied. Then, the aggregate expenditure of
an average family on various commodities is
estimated. These values constitute the
weights.
Formula:
CPI =  RW
W
 Where, R = Current years Price
relatives of
various items
W = weights of various
items
Steps:
1. Calculate price relatives for the current year
(P1/P0 x 100) and denote it by R.
2. Multiplying the price in the base year (P0) with
quantity in the base year (Q0) to calculate the
weight of a commodity, i.e. to get W.
3. Multiply the price relatives (R) with weight (W)
of each commodity and obtain its total to get
RW.
4. Obtain the sum total of weights to get W.
5. Apply the formula:
Consumer Price Index =  RW
W
1. Unit Test
2. Time Reversibility
Test
3. Factor Reversibility
Test
4. Circular Test
1. Helps in Policy Formulation.
2. Index numbers act as Economic Barometers.
3. Help in studying trends and forecasting
demand and supply.
4. To measure and compare changes.
5. Index numbers help to measure purchasing
power.
6. Index numbers help in deflating various
values.
7. Indicator of rate of Inflation.
8. It is very useful in deflating.
9. Helps us to measure changes in price level.
10. It helps us to know changes in cost of living
.
11. It helps government in adjustment of salaries
and allowances.
12. It is Useful to Business Community .
13. It gives Information to Politicians.
14. It gives Information regarding foreign
trade.
1. Provides relative changes only
2. Lack of Perfect Accuracy
3. Difference between purpose and method of
construction
4. Ignores qualitative changes
5. Manipulations are possible
6. There may be errors in the choice of base
periods or weights.
7. Comparisons of changes in variables over long
periods are not reliable
8. They are not capable of being used for any
other purpose than the one for which they
have been constructed particularly.