Chapter Eight: Index

Numbers
 INDEX NUMBERS
Index number is a statistical measurement and is counted as a Parometer of
economic activity, because it measures the up and down with respect to time or

space occurs in the prices/quantities of a commodity or a group of different

commodities.
Index number is a device which measures the level of a certain phenomenon at
any given period in comparison with the level of the same phenomenon at some
standard period, called the base period.
Or index number is a statistical quantity that measures an average change in the
prices/quantities of commodities with respect to time or space. For example,
cost of education for a student at different institutions, wages of workers,
Pakistan exports and imports etc.
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The time may be an hour, day, month, quarter or year. The time is generally
called period. Where as the space means, the change of place, for example,
comparison of wheat prices in Peshawar with that in Lahore city. So Peshawar
and Lahore are two different places (spaces).
Index number is broadly categorized into simple and composite index numbers.

Index Numbers

Simple Index Number Composite Index Number

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 SIMPLE AND COMPOSITE INDEX NUMBERS

An index number computed for a single commodity, is called simple index

number.” For example, index number of wheat prices, index number of Shama
Ghee and index number of cotton export etc. Here, in all the examples only one
commodity has been taken into account, so the index number computed is labeled
as simple index number.

An index number computed for two or more than two commodities, is called
composite index number.” For example, index number of Pakistan exports
(Pakistan exports different commodities i.e. more than one commodity at each
period), index number of industrial production, consumer price index numbers
and whole sale price index numbers etc. Composite indexes are more generally
used as compare to simple index number because many of the index numbers are
composite in nature.
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 Composite
Index Numbers

Unweighted Weighted
Index Number Index Number

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 FIXED BASE AND CHAIN BASE METHODS

Fixed Base Method: If a series of prices or quantities for a number of years is

given, then calculation of index number for each year with regard to a fixed year
is called the construction of index number by fixed base method.

In this method the prices or quantities of a particular period/year is used as a

base, the base period should not too far distant in the past and should be a normal
period, i.e. a period which is free from financial crisis and has economic stability.

But according to Croxton and Cowden, it is not possible, that no one period is
perfectly normal to be a good base for comparison, because Prices are always
advancing or receding with the business cycle. Thus, in case of unavailability of
suitable base period, the averages of prices of several periods/years are taken as
the base. This average minimizes the influence of abnormal and disrupted
economic conditions.
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 FIXED BASE METHOD-continued

To compute index number by fix base method, the value of the base period is
taken as100. The index numbers for other periods/years are computed by
dividing the price of a given year by the price of a base year, the values so
obtained are called price relatives. These price relatives are then expressed as a
percentage. In case of composite index number, an average of the percentage
price relatives gives the index for the given period. The price relative is a pure
number i.e. it is independent of any unit of measurement.

Price of the given period commodity

Pon 100
Price of the base period
commodity
Pon 100
P Pn 0
 Example: The following show the price (Rs.) of 15 bags of wheat for the years
1980-1990.
Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 190

Price 6983 7222 7393 7343 7258 7403 7706 7308 7729 7844 7911

 Calculate the price index numbers for the years 1981-1990, taking the price
of 1980 as the base.
 Also find the index numbers by taking the average of first six years as the
base.
Solution: By definition, the price index for given year (P0n) is computed by the
Pn Price of the given period commodity
Pon 100 100
P 0 Price of the base period commodity

ndex numbers for given period taking 1980 = 100, are given in the follo
Table.
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Year Price i. Pon = Pn/P0 100 ii. P0n = Pn/7267.67  100

1980 6983 100 96.08

1981 7222 103.42 99.37
1982 7393 105.93 101.78
1983 7343 105.16 101.04
1984 7258 103.94 99.87
1985 7403 106.01 101.86
1986 7706 110.35 106.03
1987 7308 104.65 100.55
1988 7729 110.68 106.35
1989 7844 112.33 107.93
1990 7911 113.29 108.85

Average of the price of first six years = (6983+7222+ … +7403)/6 = 7267.67

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 CHAIN BASE METHOD
Chain Base Method

A fixed base method compare changes in the prices of commodities of several

years with that of the base year. As time passes, the tastes and habits of the people
changes due to the relative importance of the commodities, change in the quality
of the commodities and discovery of new commodities. Therefore, it becomes
necessary to shift the base year frequently and hence the chain base method is
useful for construction of index numbers.

In this method, the base period is not fixed but it changes from year to year.
According to this method, the price of the preceding year is taken as base and
thus the relatives are computed (called link relatives). These link relatives are
expressed as percentages by multiplying them by 100.

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 CHAIN BASE METHOD-continued
Price of the given period
P
(n1)n commodity
Price of preceding
100 period commodity
Pn
P
(n1)n  100
Pn1
A sequence of link relatives is presented as: P 01 12 ,P23 ,P ,(n1)n
,P

These link relatives are can not be directly used for comparisons of several years.
To make comparisons of index numbers for several years, the link relatives are
converted back to fixed base. This process of conversion is called the changing
process and the indices thus obtained are called chain indices.

Mathematically, the various terms of chain indices are obtained by the following
expressions.
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 CHAIN BASE METHOD-continued

P 01  P02 ( first link relative)

P 02  P  P
01 12
P  P P  P
03 01 12 23

P0 n P 01 P 12 23 P
n ( n1)  P

Price index Fixed base Chain base

P01 P1/P0 P1/P0

P02 P2/P0 P01  P12 = P1/P0  P2/P1 = P2/P0 = P02

P03 P3/P0 P01  P12  P23 = P1/P0  P2/P1  P3/P2 = P3/P0 = P03

P04 P4/P0 P01  P12  P23  P34 = P1/P0  P2/P1  P3/P2  P4/P3 = P04
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 Example 5.2: The following present the prices (Rs.) per 20 kgs of wheat for the years
1980-1987. Calculate the chain indices taking 1980 as the base.
Year 1980 1981 1982 1983 1984 1985 1986 1987

Price 58 58 64 64 70 80 80 83

Solution: To compute chain indices, first of all we calculate the link relatives by using the
following formula.
Price of the given period commodity Pn
P (n1)n 100 100
Price of preceding period commodity Pn1

Year Price (unit) Link Relatives Chain indices

1980 58 100 100
1981 58 (58/58)  100 = 100 (100100)/100 = 100
1982 64 (64/58)  100 = 110.34 (100110.34)/100 = 110.34
1983 64 (64/64)  100 = 100 (110.34100)/100 = 110.34
1984 70 109.38 (110.34109.38)/100 = 120.69
1985 80 114.29 137.94
1986 80 100 137.94
1987 83 103.75 143.11
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 STEPS IN CONSTRUCTION OF INDEX NUMBER

1.
Purpose of index number

2.
Selection of commodities

3.Collection of prices

4.
Selection of base period

5. Selection of an appropriate average

Selection
6. of suitable weights

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 WEIGHTED PRICE INDEX NUMBERS

1.LASPEYR’S PRICE INDEX NUMBER P0n =  n 0 100

Pq
 P0 q 0
 Pqn n
100
2. PAASCHE’S PRICE INDEX NUMBER P 0n=  P 0q n

3. FISHER’S PRICE INDEX NUMBER P0n=  

Pq n n Pnq0
 
  100
P0qn P0q0

4.MARSHAL EDGE-WORTH PRICE INDEX NUMBER

P0n= 
Pn (qn + q0 )
100
 P(q+q) 0 n 0

=
 Pn qq
n 0
100
P 0n
5. WALSH PRICE INDEX NUMBER
 P0 q n q0

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 NUMERICAL QUESTION
STATEMENT:
Using the following data, showing --------------------------------
During the years 1990 and 1995. Compute, Laspeyr, Paasche and Fisher price
Index numbers.

Base Period (1990) Current Period (1995)

Commodity Price Quantity Price Quantity
A 20 15 25 14
B 25 20 28 22
C 23 18 26 20
D 21 17 28 14
E 30 25 40 22

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 Base periodCurrent period
(1990) (1995)

Commodity P0 q0 P1 q1 P1q0 P1q1 P0q0 P0q1

A 20 15 25 14 375 350 300 280

B 25 20 28 22 560 616 500 550

C 23 18 26 20 468 520 414 460

D 21 17 28 14 476 392 357 294

E 30 25 40 22 1000 880 750 660

Total 2879 2758 2321 2244

1. Laspeyr’s price index for 1995: P01 = (2758/2244)*100 =122.91

2. Paasche’s price index for 1995: P01 = (2879/2321)*100 =124.04

3. Fisher’s price index for 1995: P01= (2758/2244) (2879/2321)100

123.47
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