INDEX NUMBERS

Meaning of Index Numbers

An index number is a statistical device for measuring changes in the magnitude of a group of
related variables.
Types of Index numbers

1. Price index numbers: A price index is a measure of changes in prices of a variable or

group of variables over time. This type of index number is often used to compare the prices
of the goods from one period of time to the base period. The CPI is an example of a price
index.
2. Quantity index numbers: A quantity index number is a measure of changes in quantity
between time periods. These index numbers are often used to measure things such as
employment, production, or construction. An example would be an index that measures
quantity changes in industrial production.
3. Value index numbers: A value index number measures changes in the aggregate value of
a variable or group of variables over time. Value index numbers are used to track changes in
things such as trade, inventories, and sales.
Construction of an Index Number
A. Simple Index Numbers
There are two methods of constructing simple index numbers.
(i) Simple Aggregative Method: In this method, we use the following formula

Here, P01 = Price index of current year

ΣP1 = Sum of prices of the commodities in the current year
ΣP0 = Sum of prices of the commodities in the base year

(ii) Simple Average of Price Relatives Method

According to this method, we first find out price relatives from each commodity and then
take simple average of all the prices relatives.

B. Weighted Index Numbers

(i) Weighted Aggregative Method
Laspeyre’s Method

Here, P01 = Index number for the current year in relation to the base year
W = weight R = price relative
This method uses the base period quantities as weights. A weighted aggregative price index
using base period quantities as weights, is also known as Laspeyre’s price index.

Paasche’s Method
Since the current period quantities differ from the base period quantities, the index number
using current period weights gives a different value of the index number

It uses the current period quantities as weights. A weighted aggregative price index using
current period quantities as weights is known as Paasche’s price index.
Weighted Average of Price Relatives Method

CONSUMER PRICE INDEX

The index reflecting the average increase in the cost of the commodities consumed by a class
of people and helping them maintain the same standard of living in the current year as in the
base year is known as Consumer Price Index (CPI). The main aim behind their design is the
measurement of the effects of change in the prices of a basket of goods and services on the
purchasing power of a specific section of society during the current period with respect to the
base period. Other names for Consumer Price Index are Cost of Living Index Numbers,
Price of Living Index Numbers, and Retail Price Index Numbers.
Construction of Consumer Price Index
The two methods of constructing Consumer Price Index Numbers are Aggregate Expenditure
Method or Weighted Aggregate Method, and Family Budget Method or Method of Weighted
Average of Price Relatives.
1. Aggregate Expenditure Method
This method is quite similar to Laspeyre's Method of Constructing Weighted Index. For the
application of this method, one has to estimate the quantities of commodities consumed by
the particular group in the base year. The figures estimated are used as weights. After that, the
total expenditure on each commodity for the base and current year is calculated. The formula
to determine Consumer Price Index under this method is as follows:

2. Family Budget Method

This method involves carefully studying the family budgets of a large number of people for
whom the index is meant. After that, the aggregate expenditure of an average family on
different commodities is estimated. The estimated values constitute the weights. The formula
to determine Consumer Price Index under this method is as follows:

Uses of Consumer Price Index Number

The Consumer Price Index is important because of the following reasons:
1. It helps in formulating wage policy, negotiating wages, rent control, price policy, taxation
and general economic policy formulation.
2. It is used by government and business units for regulation of the Dearness Allowance (DA)
or for granting bonuses to employees to compensate them for the increased cost of living due
to the price rise.
3. These are also used for the measurement of purchasing power of the consumer in rupees.
The purchasing power of the rupee is the value of a rupee in a given year as compared to the
base year. The formula to calculate the purchasing power of the rupee is as follows:

4. When the price of the commodities increase, the amount of these goods and services,
which money wages (or real wages) can buy, decreases. The index number tells us the change
in real wages and the formula to determine the real wages is as follows:

5. These numbers are also used for the analysis of markets for particular kinds of goods and
services.
WHOLESALE PRICE INDEX
The Wholesale Price Index is an indicator that tracks changes in wholesale product prices.
This index measures changes in the average price of commodities traded in bulk.
Utility of Wholesale Price Index(WPI)
1. Forecasting Demand and Supply:
The demand and supply conditions in the economy are frequently predicted using the
wholesale pricing indices.
• Growth in the wholesale price index implies that there is surplus demand. It is an
instance where supply is insufficient to meet demand.
• However, a drop in the wholesale price index indicates a demand deficit. In this
instance, demand is less than supply.
2. Computation of Monetary Value and Real Value:
The real and monetary values of aggregates, like national income and expenditure can be
calculated using the wholesale price indices.
3. Indicator of Rate of Inflation:
Inflation is defined as the rate at which prices are likely to increase over time. The wholesale
pricing index is also used to estimate an economy's inflation rate.
• An increase in the WPI signifies a decrease in the purchasing power of money.
• The WPI number helps determine the nation's inflation rate, which may be computed
as:

4. Useful in Cost Evaluation of various projects:

The construction of large facilities, like airports and shopping malls is a long-term effort that
will require significant future financial outflows.
• As prices rise over time, the project's initial estimated cost will also increase.
• The wholesale price index, which depicts the rate of inflation, must be taken into
account when estimating the revised price.
• In order to determine the true cost of such initiatives, wholesale price indices are
helpful.
INDEX NUMBER OF INDUSTRIAL PRODUCTION
The changes in the level of industrial production across many industries are measured by the
index number of industrial production.
IIP =
INFLATION AND INDEX NUMBERS
Inflation is defined as a consistent and significant rise in prices in a country over a time
period. It cannot be described as a slight increase in prices or an irregular increase in prices,
but, as a situation characterized by a sustained increase in the general price level.
Features of Inflation and Index Numbers:
1. The most popular price index for determining the country's inflation rate is the
Wholesale Price Index.
2. It reveals the price movement of commodities in all trade and transactions.
3. It is merely a generic index that comprehensively captures price variations.
4. The Wholesale Price Index is available on weekly basis and the shortest time lag
possible is 2 weeks.
Due to all of these characteristics, the Wholesale Price Index is the most often used inflation
measure.
The weekly relative changes in the price index are measured by the rate of inflation.