Index

Numbers

ANKIT KUMAR
PGT, ECONOMICS
An Index Number is a statistical device for measuring changes in the
magnitude of a group of related variables.

❑ Index numbers measures the changes with respect to time,

geographical location or some other characteristics.

❑ It also measures the changes in the value of variables like prices of

specified list of commodities, volume of production in different
sectors, cost of living etc.

❑ Index number are known as ‘Barometer of Economic Activity’.

 Characteristics of Index Numbers

1. Index Number are specialised averages.

2. Index numbers are expressed in percentages.

3. Index numbers measure the effect of changes in relation to time or

place.

4. Index numbers measures the change not capable of direct

measurement.
 Problems in Construction of Index Numbers
1. Purpose of Index Numbers.

2. Selection of Base year.

3. Selection of number of items or commodities.

4. Selection of sources of data.

5. Price Quotation.

6. Selection of the Average.

7. Selection of the Appropriate Weight.

8. Selection of an appropriate formula.

 Types of Index Numbers

Price Quantity Value

Index Numbers Index Numbers Index Numbers
 Price Index Numbers

The price Index Numbers measure the general changes in prices

between the current year and base year.

❑ General price index is used to measure the value of money.

❑ Price index numbers are the most important and are commonly
employed in various economic and business contexts.

❑ When percentage changes in prices are different for different

commodities, then price index helps in representing these changes
by a single numerical measure.
 Price
Index Numbers

Wholesale Retail Price

Index Numbers Index Numbers
Wholesale price index numbers:
It reflects the general price level for a group of items
taken as a whole.

It acts as an indicator of the rate of inflation.

Retail Index Numbers:

It reflects the general changes in the retail prices of
various items including food, housing, clothing and so on.

The consumer Price Index is a special type of retail price index.

 Quantitative Index Numbers

The quantity index numbers measure average change in quantities and

enable us to compare changes in physical quantity of goods produced,
consumed or sold.

❑ The level of physical output in an economy can be easily studies by

this type of index number.

❑ They can be constructed by using both simple as well as weighted

method.
 Value Index Numbers

Value index numbers compare the total value of some period with the
total value of the base period.

❑ The study of changes in the total value of production such as indices

of retail sales or profit or inventories, can be made by value index
numbers.
 Methods
of
constructing price Index Numbers
The various methods of constructing price numbers can be grouped
under two heads:

1. Unweighted or Simple index numbers;

2. Weighted index numbers.

Both of these methods of constructing index numbers are further classified as:

I. Simple Aggregative Method;

II. Simple Average of Price Relatives method.

 Methods of Constructing Price Index Numbers

Simple Weighted
Index Numbers Index Numbers

Simple Simple Averages of Weighted Weighted Averages of

Aggregative Method Price Relatives Method Aggregative Method Price Relatives Method
 Unweighted Index Numbers

In the unweighted index numbers, each item have the same weight as
no weight is expressly assigned to any item.

There are two unweighted methods:

1. Simple Aggregative Method

2. Simple Average of Price Relative Method

 Simple Aggregative Method

This is simplest method of constructing index numbers.

In this method, aggregate prices of all the selected commodities in

the current year are expressed as a percentage of the aggregate
prices in the base year.
Construct Index Numbers for 2016-17 taking 2011-12 as the base year
from the following data by Simple Aggregate Method.

Commodity Price in 2011-12 Price in 2016-17

Wheat 20 25
Rice 30 40
Pulses 60 80
Sugar 30 40
 Price in 2011-12 Price in 2016-17
Commodity Price in 2011-12 Price in 2016-17
(P0) (P1)

wheat 20 25 185
= X 100
Rice 30 40 140
Pulses 60 80 = 132.14
Sugar 30 40
 Limitations of Simple Aggregative Method

❑ It is influenced by the magnitude of prices.

❑ Equal weights are assigned to every item.

❑ Prices of various commodities may be quoted in different units.

 Simple Average of Price Relative Method

This index is an improvement over the simple aggregative price

index.

According to this method, firstly price relatives for each commodity

is calculated and then take simple average of the all price relatives.
Construct Index Numbers for 2016-17 taking 2011-12 as the base by
Simple average of price relative Method.

Commodity A B C D

Prices (2011-12) 10 20 30 40

Prices (2016-17) 13 17 60 70
 Price in 2011-12 Price in 2016-17
Commodity Price in 2011-12 Price in 2016-17
(P0) (P1)

A 10 13 590
=
B 20 17 4
C 30 60 = 147.5
D 40 70
 Merits of Simple Average of Price relatives Method

❑ The value of this index is not affected by the units in which prices of
commodities are quoted.

❑ Equal importance is given to each commodity and extreme

commodities do not influence the index number.
 Demerits of Simple Average of Price relatives Method

❑ As it is unweighted index, each price relative is given equal

importance.

❑ Difficulty is faced with regard to the selection of an appropriate

average.
 Weighted Index Numbers
In the Weighted index numbers, rational weights are assigned to all
items or commodities in a explicit manner. Such weights indicate the
relative importance of items included in the calculation of an index.

Weighted index numbers can be constructed by two methods:

1. Weighted Aggregative Method

2. Weighted Average of Price Relative Method

 Weighted Aggregative Method
Under this method, weights are assigned to various items and
Weighted aggregate of the prices are obtained.

There are many formulae to construct weighted index numbers. We

discuss the following three methods:

1. Laspeyre’s Method

2. Paasche’s Method

3. Fisher’s Method
 Laspeyre’s Method

In this method weights are represented by the quantities of the

commodities in the base year.
 Paasche’s Method

In this method weights are determined by quantities in the given

year.
 Fisher’s Method

Fisher’s ideal index is the geometric mean of the Laspeyre and

passche indices.
From the following data, calculate price index number for 2016 with
2011 as base year by :
(1) Laspeyre’s Method (2) Paasche’s Method (3) Fisher’s Method

Commodity Base Year (2011) Current Year (2016)

p0 q0 p1 q1
A 20 8 40 6
B 50 10 60 5
C 40 15 50 15
D 20 20 20 25
Commodity p0 q0 p1 q1

A 20 8 40 6 320 160 240 120

B 50 10 60 5 600 500 300 250

C 40 15 50 15 750 600 750 600

D 20 20 20 25 400 400 500 500

Laspeyre’s Method:
2070 20700
= = = 124.69
1660 166
Paasche’s Method:
1790 17900
= = = 121.77
1470 1470
Fisher’s Method:
2070 1790 37053
= X X 100 = X 100
1660 1470 24402
X 100 X 100
 Fisher’s Method: Ideal Method

The formula is based on geometric mean, which is considered to be

the best average for constructing index numbers.

It Considers both base year and current year quantities as weights.

It satisfies time reversal test and factor reversal test.

 Weighted Average of Price Relative method
According to this method, weighted index number is arithmetic mean of price
relatives.

In this method, the price relatives for the current year are calculated on the
basis of the base year prices.

These price relatives are multiplied by the respective weights of the items.

These products are added up and divided by the sum of weights.

Calculate weighted average of price relative index number of prices for
2015 on the basis of 2010 of the following data:
Commodities Quantity (in 2010) Price (in 2010) Price (in 2015)

A 20 20 35
B 12 15 18
C 8 10 11
D 4 5 5
E 6 4 5
Commodity q0 p0 p1 W

A 20 20 35 400 70000

B 12 15 18 180 21600
105400
C 8 10 11 80 8800 =
704
D 4 5 5 20 2000
= 149.72
E 6 4 5 24 3000
 Consumer Price Index
Consumer Price Index reflects the average increase in the cost of the
commodities consumed by a class of people so that they can maintain the same
standard of living in the current year as in the base year.

They are designed to measure effects of change in prices of a basket of goods

and services on purchasing power of a particular section of the society during
any given period with respect to some fixed period.

The consumer price index numbers are also known as:

I. Cost of living Index Numbers;
II. Retail Price Index Numbers;
III. Price of Living Index Numbers.
 Need for Consumer Price Index
❑ The need for constructing consumer price index numbers arises
because general index numbers do not highlight the effect of rise or
fall in prices of various commodities consumed by different classes
of people on their cost of living.

❑ The consumption pattern of rich, poor and middle class people

varies widely.

❑ The Consumer price index helps us in determining the effect of rise

and fall in prices on different classes of consumers living in different
areas.
 Construction of Consumer Price Index

The steps involved in construction of consumer price index are:

1. Determining the scope and coverage of the Index

2. Family budget enquiry

3. Obtaining price quotations

 Difficulties in Construction of Consumer Price Index
❑ Prices used in the construction of cost of living index are retail
prices, which vary from shop to shop, place to place and consumer
to consumer.

❑ It includes so many commodities of unstable quality, which will not

be used at different point of time.

❑ The ratio of expenditure on different commodities at different point

of time and by various person are not same.
 Methods of constructing CPI

The consumer price index numbers are constructed by two methods:

1. Aggregate Expenditure method or Weighted Aggregative Method

2. Family Budget Method or Method of Weighted Average of Price Relatives.

 Aggregate Expenditure Method
This method is similar to Laspeyer’s method of constructing weighted index.

To apply this method, the quantities of commodities consumed 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 are calculated.
Calculate cost of living index, for the following data, using Aggregate
expenditure Method.
Commodities Price (in 2011) Quantity (in 2011) Price (in 2019)

A 10 15 15
B 8 20 12
C 20 10 24
D 32 5 40
E 15 6 20
F 12 2 18
G 8 1 10
Commodity p0 q0 p1

A 10 15 15 225 150

B 8 20 12 240 160
1071
C 20 10 24 240 200 =
798
D 32 5 40 200 160
107100
E 16 6 20 120 96 =
798
F 12 2 18 36 24
= 134.21
G 8 1 10 10 8
 Family Budget Method
In this method, the family budget 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 commodity is

estimated.

These values constitutes the weights.

Calculate cost of living index, for the following data, using Family
Budget method.
Commodities Price (in 2011) Quantity (in 2011) Price (in 2019)

A 10 15 15
B 8 20 12
C 20 10 24
D 32 5 40
E 15 6 20
F 12 2 18
G 8 1 10
Commodity p0 q0 p1 W

A 10 15 15 150 22500

B 8 20 12 160 24000

C 20 10 24 200 24000 107100

=
D 32 5 40 160 20000 798
E 16 6 20 96 12000 = 134.21
F 12 2 18 24 3600

G 8 1 10 8 1000
 Uses of CPI
1. Consumer price index numbers helps in wage negotiations, formulation of
wage policy, rent control, taxation and general economic policy formulation.

2. The government and business units use the consumer price index numbers to
regulate the Dearness allowance or grant of bonus to employees.

3. The CPI are used to measure purchasing power of the consumer in rupees.
4. With the increase in prices, the amount of goods and services which money
wages can buy goes on decreasing. Index numbers tell us the change in real
wages.

5. The CPI are also used for analysing markets for particular kinds of goods and
services.
 All India CPI
In India, three Consumer Price Index Numbers are constructed:

1. CPI for Industrial Workers with 1982 as base year

2. CPI for urban non-manual employees with base year 1984-85

3. CPI for agricultural labours with 1986-87 as base year

✔ They are routinely calculates every month to analyse the impact of changes in
the retail price on the cost of living of these three broad categories of
consumers.
 Wholesale Price Index Numbers
Wholesale price index numbers are those price index numbers which measure
the general changes in the wholesale prices of goods in a country.

This index is restricted to commodities which are mainly trades on a

wholesale basis.

Wholesale price index numbers also act as an indicator of changes in

economy.

In India first WPI was compiled in 1947.

 Groups of Commodities for WPI
In India, the commodities traded on wholesale basis are broadly classified into
three major groups:

1. Primary Articles:
The number of items in this category are 98 and the weights are 22.02%.

2. Energy Articles:
The number of items in this category are 19 and the weights are 14.23%.

3. Manufactured Articles:
The number of items in this category are 318 and the weights are 63.75%.
 WPI as a indicator of Inflation
Inflation is a persistent and appreciable rise in general level of prices.

An increase in WPI indicates the rate at which the purchasing power of money
is decreasing.

WPI numbers helps in finding out the rate of inflation in the country.
 Utility of WPI

1. Indicator of Inflation

2. Forecasting Demand and Supply

3. Helps in determining real changes in aggregate

4. Useful in Cost evaluation of various projects.

 Index of Industrial Production
The index number of industrial production measure changes in the level of
industrial production comprising many industries.

They measure the quantity of production in the area of manufacturing,

mining and utilities.

Index numbers of industrial production are designed to measure increase or

decrease in the level of industrial production.

This index is quantity index not a value index.

❑ Generally, data of industrial production are collected under the following
heads:
1. Mining industries
2. Metallurgical Industries
3. Mechanical industries
4. Textile Industries
5. Industries subject to excise duties
6. Miscellaneous

❑ The data relating to the production of the above mentioned industries are
collected either monthly, quarterly or yearly.
 Uses of Index numbers
1. Helps in Policy formulation

2. Act as Economic Barometers

3. Helps in studying trends

4. To measure and compare changes

5. Help to measure purchasing power

6. Help in deflating various values.

 Limitations of Index numbers

1. Provides relative changes only

2. Lack of perfect accuracy

3. Difference between purpose and method of construction

4. Ignore qualitative changes

5. Manipulations are possible.

 Inflation and Index Numbers
Inflation is described as a situation characterised by a sustained increase in the
general price level.

The wholesale price Index is the most widely used price index as an indicator
of the rate of inflation.

It is the only general index capturing price movements in a comprehensive

way and indicates movement in prices of commodities in all trade and
transactions.

WPI is available on a weekly basis with the shortest possible time lag of 2
weeks.
Th a n k
You

ANKIT KUMAR
PGT, ECONOMICS