Unit – I

INDEX NUMBERS

Introduction: In many practical real situations, to improve the economic conditions, quantity and quality
of the productivity, the standard of living of the country and for many other reasons, it is essential to study
the changes of several economic related variables like agricultural production, industrial production, prices
of various commodities, cost of living, imports and exports of various commodities, sales of various
commodities, national income, etc. A simple and easily calculated statistical device is needed to study the
relative changes of these kind of economic variables under a particular study. An index number is such
statistical measure which clearly indicates changes in the variables. This helps in the formulation, planning
and execution of decision of various management, business and economic concern problems. Index
numbers study the economic behaviour of the variables, hence it is known as economic barometers.

Definition: Index numbers are statistical devices to measure the relative change in the level of phenomenon
with respect to time or geographical region or any other characteristics.

Index numbers which are calculated based on some standard period called base period and
calculated for a given time period called current period.

Various Problems involved in the construction of Index numbers: Following are the various problems
involved in the construction of Index numbers.

1. The purpose of Index number: An Index number which is properly designed for a purpose can be most
useful and powerful tool otherwise it can be equally misleading and dangerous. Thus, the first and foremost
problem is to determine the purpose of index number without which it is not possible to follow the steps in
its construction. Moreover precise statement of the purpose usually settles some related problems, e.g., if
the purpose of index number is to measure the change in the production of steel, the problem of selection
of items is automatically settled.

2. Selection of commodities: The next step is to select the commodities which are relevant to the Index.
For example, if the purpose of an Index is to measure the cost of living of low Income group we should
select only those commodities which are consumed by persons belonging to this group and proper care
should be taken not to include the goods or services which are consumed by middle – Income or high –
Income group. For such an Index, selection of commodities like cosmetics and other luxury goods like
Scooters, cars, refrigerators, television sets etc., will be absolutely useless.

The best solution to the problem of selection of items for any index is

a). to split the whole group of commodities into various homogeneous subgroups like cereals, milk
and milk products, clothing, iron and steel, electrical appliances and fuel, etc., so that the price movement
of various commodities within any subgroup follows almost the same pattern, and

b). to select an adequate number of representative items from each sub – group.

3. Data for Index numbers: The data, usually the set of prices and of quantities consumed of the selected
commodities for different periods, places, etc., constitute the raw material for the construction of index
numbers. The data should be collected from reliable sources such as standard trade journals, official
publications, periodical special reports from the producers, exporters, etc., The principles of data collection,
i.e., accuracy, comparability, sample representatives and adequacy should be borne in mind. For example,
for the construction of retail price index numbers, the price quotations for an adequate number of
commodities should be obtained from super bazaars, fair price shops, departmental stores, etc., and not
from wholesale dealers.

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4. Selection of Base Period: The period with which the comparisons of relative changes in the level of a
phenomenon are made is termed as ‘base period’ and the index for this period is always taken as 100. The
following are basic criteria for the choice of the base period.

1. The ‘base period’ must be a ‘normal period’: i.e., a period free from all sorts of abnormalities
or chance fluctuations such as economic boom or depression, labour strikes, wars, floods,
earthquakes etc. If the base period be taken as a period of economic instability or depression in
which the prices of various commodities and goods, due to their scarcity, have been abnormally
high then the comparison of price relatives in any given year will not be of much practical utility.

2. The base should not be too distant from the given period: Since Index numbers are essential tools
in business planning and in formulation of executive decisions, the base period should not be too
far to the given period because due to rapid change of events, distant base period is likely to be
entirely different from the given period. Moreover, if the base year is shifted far away from the
given period, it is possible that the pattern of consumption of commodities may change. For
example, to take decision regarding D.A. increment to government employees the prices should be
compared with the period when last D.A. was announced.

5. Type of average to be used: Since index numbers are specialized averages, a judicious choice of average
to be used in their construction is of great importance. Usually the following averages are used

1) Arithmetic Mean (A.M.): simple or Weighted,

2) Geometric Mean (G.M.): simple or Weighted,

3) Median

Median, though easiest to calculate of all the three, completely ignores the extreme observations
while arithmetic mean, though easy to calculate, is unduly affected by extreme observations. Moreover,
neither arithmetic mean nor median are reversible and hence do not reflect typical movements of prices or
quantities. Since in the construction of index numbers we deal with ratio or relative changes and since
geometric mean.

1) Gives equal weights to equal ratios of change.

2) Does not give undue weightage to extreme observations, and

3) G.M. based indices are reversible.

From theoretical considerations G.M. is the most appropriate average to be used. But G.M. is not
used as often as A.M. because of its computational difficulties. But in terms of greater accuracy and
precision, G.M. should be recommended.

6. Selection of appropriate weights: Generally, various commodities say, wheat, rice, kerosene, clothing,
etc., included in the index are not of equal importance, proper weights should be attached to them to take
into account their relative importance. Thus there are two types of indices

a) Unweighted Indices: In which no specific weights are attached to various

commodities

b) Weighted Indices: In which appropriate weights are assigned to various items

7. Choice of Formula: Various formulas are available for the construction of index numbers. The selection
of suitable formula depends on purpose of index and prices, quantities of selected commodities.

Notations:

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Let pij=price of jth commodity in the ith year.

qij=quantity of jth commodity consumed in the ith year.

vij= pijxqij is value of the jth commodity in the ith year.

Where i=0,1,2,…..k, j=1,2,…..,n.

If we consider years, then ‘0’ indicates base year and ‘i' indicates the current year.

Wj is weights assigned to jth commodity

Poi is price index number

Qoi is quantity index number

Voi is Value index number.

Where ‘0’ is the base year and ‘i’ is current year.

Classification of Index Numbers: Based on their purpose, the index numbers are classified into the
following ways:

(i). Price index numbers

(ii). Quantity index numbers

(iii). Value index numbers

(iv). Special purpose index numbers (e.g. cost of living index numbers).

Types of Index Numbers:

There are two types of index numbers unweighted and weighted index numbers.

Simple (or Unweighted) Index Numbers:

In simple index numbers, all the commodities will have equal importance i.e., no special weights
will be assigned.

Simple Price Index Number: The relative changes in the price in the ith year (i=1,2,….k) compared to the
base year (i=0) is measured by simple price index number. It is expressed as aggregate of prices in the
current year as a percentage of aggregate of prices in the base year and is given by
n

p
j 1
ij
p
P0i  100 Usually write P0i 
ij
100
n

p 0j
p 0j

j 1

Simple Quantity Index Number: The relative changes in the quantities in the ith year (i=1,2,…..,k)
compared to the base year (i=0) is measured by simple quantity index number. It is expressed as aggregate
of prices in the current year as a percentage of aggregate of prices in the base year, is given by

Q0i 
q ij
100
q 0j

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Simple Averages of Price Relatives: First we obtain the price relative of jth commodity by,
pij
, j  1, 2,....., k
p0 j

Now we express the average of these price relatives as an index using arithmetic mean as follows:

1 n  pij 
P0i  AM      100
n j 1  p0 j 

Using geometric mean as follows:

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 n  pij   2  1 n  pij  
P0i  GM        100  Anti log  2   log 

 j 1  p0 j    n  p  
    j 1  0 j 

Using harmonic mean as follows:

1 n
P0i  HM    100
  n  pij 
    
1 n  1  j 1  p0 j 
 
n j 1  pij  
 100 
  p0 j  
  
Merits of Simple Index Numbers:

1. These are very simple and easy to calculate.

2. These are no affected by units in which prices are quoted.

Demerits of Simple Index Numbers:

1. Relative importance of various commodities is not considered.

Weighted Aggregate Index Numbers: In weighted index numbers, we assign appropriate weights to
various commodities i.e., the importance of each commodity will be considered.

Weighted Aggregate Price Index Numbers: If wj is the weight of the jth commodity, then weighted
aggregate price index number is given by

P0i 
p w ij j
100
p w 0j j

Weights may be considered as quantities consumed in the base year or quantities consumed in the
current year or average of both years.

Laspeyre’s weighted aggregate price index number: If weights are considered as quantities consumed
in the base year i.e., w j  q0 j , then Laspeyre’s weighted aggregate price index number is given by

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 p q
i  100 This method is also known as base year method.
ij 0 j
P0La
p q0j 0j

Paasche’s weighted aggregate price index number: In this method, weights are considered as quantities
consumed in the current year i.e., w j  qij , then Paasche’s weighted aggregate price index number is given
by

p q
i  100 . This method is also known as current year method.
ij ij
P0pa
p q0 j ij

Drobish-Bowley weighted aggregate price index number: Drobish-Bowley price index number is the
arithmetic mean of Laspeyr’'s and Paasche’s index numbers and is given by

 P0i  PoiPa     ii 0 j   ii ij  100

1 La 1 pq pq 
P0DB 
2   p0i q0 j  p0i qij 
i
2

Marshall-Edgeworth weighted aggregate price index number: In this formula, weights are taken as the
q0 j  qij
arithmetic mean of the base year and current year quantities i.e., w j  , is given by
2

 q0 j  qij 
p
 2  100   pij  q0 j  qij  100
 ij 
P0ME 
q q   p0 j  q0 j  qij 
i

 p0 j  0 j 2 ij 
 
Fisher’s weighted aggregate price index number: Irving Fisher index is the geometric mean of
Laspeyre’s and Paasche’s index formulae, given by

P0Fi  P0La
p q p q
i  P0 i   100
Pa ij 0 j ij ij

p q0j 0j p q
0 j ij

Kelley’s Fixed weight index number: In the kelley’s index formula, the weights wj are taken as quantities
with reference to some time period and kept constant for all periods or the average of the quantities of two
or more years (usually arithmetic mean or geometric mean are used). Let w j and qj as fixed weight, then
kelly’s fixed index number is

P0Ki 
p qij j
100
p q
0j j

Weighted Aggregate Quantity Index Numbers: If the prices and quantites are interchanged in the
weighted aggregate price index numbers, we get the quantity index numbers.

Laspeyre’s Quantity index number:

Q0Lai 
q ij p0 j
100
q 0j p0 j

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Paasche’s Quantity index number:

Q0pai 
q ij pij
100 .
q 0j pij

Drobish-Bowley Quantity index number:

Q0i  QoiPa     ii 0 j   ii ij   100

1 La 1 q p q p 
i 
Q0DB
2 2   q0i p0 j  q0i pij 

Marshall-Edgeworth Quantity index number:

q  p  pij 
i  100
ij 0j
Q0ME
q  p
0j 0j  pij 

Fisher’s Quantity index number:

Q0Fi 
q ij p0 j

q ij pij
100
q 0j p0 j q 0j pij

Kelley’s Quantity index number:

P0Ki 
q ij pj
100
q 0j pj

Weighted Averages of Price Relatives: If wj (j=1,2,…..,n) is weight assigned to the jth commodity, obtain
pij
the price relative of jth commodity by , j  1, 2,....., n . Then we can express the weighted average of
p0 j
price relatives as an index using arithmetic mean as follows:

 pij 
n

w
p
 j

P0i  AM  
j 1  0 j  100
n

 wj j 1

Using geometric mean as follows:

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 n  p w j   w j  1   pij   
P0i  AM     ij   100  Anti log  2    w j .log10  
 j 1  p0 j     w j   p   
    0 j  

Using harmonic mean as follows:

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 n

1
w j

P0i  HM    j 1
100
1 n
1  p 
w
n

 wj j 1
j
 pij   w j  ij 
 p0 j 
  100 j 1  
 p0 j 

Value Index Numbers: The value index numbers are expressed as aggregate expenditure of the current
year as a percentage of aggregate expenditure of the base year and is given by

V0i 
p q ij ij
100
p q 0j 0j

The Criteria of a good Index number: There are four mathematical tests to decide the best index formula
among various formulae. If any index number formula satisfies maximum number of tests, it is called a
good index number. This is called criteria of good index number. The four mathematical tests are given
below.

1) Unit Test

2) Time Reversal Test

3) Factor Reversal Test

4) Circular Test

Unit Test: The prices and quantities have different units, in general for various commodities in calculation
of an index number. For example, rice wheat, sugar, pulses etc., are measured in kilograms, and oil,
kerosene, etc., are measured in liters. The unit test requires the index formula to be independent of the units
of prices and quantities of various commodities. Generally all the formula satisfies this test.

Time Reversal Test: The Time Reversal Test was proposed by Irving Fisher. According to him
the Time Reversal test requires the index formula must maintain time consistency by working with both
forward and backward with reference to time.

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Let Pi 0   P0i  Pi 0  1
P0i

(i) If we consider simple price index number P0i 

p ij

p 0j

Now by interchanging the time periods 0 and i, we get Pi 0 

p0j

pij

Now, P0i  Pi 0 
p ij

p 0j
1
p 0j p ij

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I.e., simple price index formula satisfies time reversal test. Similarly simple quantity index formula satisfies
time reversal test.

p q p q
P 0i  
F ij 0 j ij ij
(ii) Consider Fisher Index formula
p q 0j 0j p q 0 j ij

p q p q
Pi0 
F 0 j ij 0j 0j
By interchanging time periods
p q p q ij ij ij 0 j

p q p q p q p q
P 0i  P i 0  
F F ij 0 j ij ij 0 j ij 0j 0j
Now consider,
p q 0j 0j p q p q p q
0 j ij ij ij ij 0 j

P P 1
F F
0i i0

i.e., Fisher price index formula and quantity index formula and quantity index formula satisfies time
reversal test.

(iii) Consider Marshal-Edgeworth Index formula

ME

 p q  p q ij 0 j ij ij ME

 p q  p q
0 j ij 0j 0j
P 0i
 p q  p q 0j 0j 0 j ij
P i0
 p q  p q
ij ij ij 0 j

ME
 Pi0 
ME  p q  p q  p q  p q
ij 0 j ij ij 0 j ij 0j 0j
1
P 0i
 p q  p q  p q  p q
0j 0j 0 j ij ij ij ij 0 j

(iv) Consider Walsch index formula

p q0 j qij p qij q0 j
P 0i  P 0i 
W ij W 0j

p 0j q0 j qij p ij qij q0 j

p q0 j qij p qij q0 j
P 0i  P 0i   1
W W ij 0j

p 0j q0 j qij p ij qij q0 j

From the above formulas simple, Fisher, Marshal-Edgeworth and Walsch price and quantity index
formulas are satisfied the time reversal test and no other index formula satisfies time reversal test.

Factor Reversal Test: The factor Reversal Test is introduced by I. Fisher. According to him, if the prices
and quantities are interchanged, the index formula should give the value index.

Symbolically P0i  Q0i  V0i 

p q ij ij

p q 0j 0j

F

p q ij 0 j

p q Q ij ij F

q ij p0 j

q ij pij
P 0i
p q 0j 0j p q 0 j ij
0i
q 0j p0 j q 0j pij

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   pij q0 j  pij qij    qij p0 j  qij pij   pij qij
P0i  Q0i           V0i
p q  p0 j qij  q p  q0 j pij  p q
 0 j 0 j   0 j 0 j  0 j 0 j

Circular Test: Circular test is based on shiftability of the base period. It is an extension of time reversal
test. For price index formula, the circular test symbolically expressed as follows for three time periods a,b,c
i.e, Pab  Pbc  Pca  1 .

There are two index formulae only satisfy the circular test, which are geometric mean of price
relatives and Kelly’s fixed weight index.

Fisher Ideal Index Number: Fisher index satisfies unit test, time reversal test and factor reversal tests.
Since among four mathematical tests, Fisher index satisfies majority of three mathematical test, it is named
as an ideal index number.

Fixed Base and Chain Base Index numbers:

Chain Base Index Numbers: The series of index numbers computing for each period with preceding
period as base period are called chain based index numbers. An appropriate index formula is to be used to
calculate these chain based indices.

If Pab is a price index number of the current period ‘b’ with the base period ‘a’. Now let
P01 , P12 , P23 ,.......P k 1k are price indices with the just preceding period as base.

The chain base index numbers are obtained by successive multiplication of P01 , P12 , P23 ,.......P k 1k
the method explained below.

P01  first link

P02  P01  P12

P03  P01  P12  P23  P02  P23
.
.
P0 k  P0 k 1  P k 1k

Construction of Chain Base Index Numbers:

Step 1: Calculate Link Relatives (LR) by expressing the current period figure as a percentage of the
preceeding period.

Current period figures

Current period LR  100
Pr evious period figures

If the figures are given for more than one commodity, then obtain link relatives for each commodity
and we take average to them

Step 2: The chain based index (CBI) of the first period is considered as 100. Then the chain base indices
are obtained by successive multiplication of the link relatives by using the following formula.

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 Current period LR  Pr eceding period CBI
Chain based index 
100

Procedure of converting Fixed base index numbers into Chain base index Numbers:

If the prices of various commodities are not available but a series of indices with a fixed base period
are available, then we can calculate the Chain based index numbers with the help of Fixed base index
numbers (FBI) by using the following formula.

Current period FBI

Current period CBI  100
Pr evious period FBI

Procedure of converting chain based index numbers into fixed base index numbers:

If the prices of different commodities are not available, but a series of chain based indices are
available in some kind of situations; then fixed base indices are calculated with the help of chain based
index numbers by using the following formula.

Current period CBI  Pr evious period FBI

Current period FBI 
100

Fixed based index numbers vs. chain based index numbers:

Fixed based index numbers Chain based index numbers

1. The base period is fixed. 1. The base is not fixed.

2. These are simple to calculate. 2. There are difficult to calculate.

3. These indices are more frequently used. 3. These indices are used rarely.

4. If the error occurs in the calculate of indices, then 4. If the error occurs in this method, the entire
error confines to that period only. series will be wrong and misleading.

5. Comparison between two adjacent time periods 5. In this method, two adjacent time periods are
is not always possible except the base period is just always comparable.
previous period.
6. In this method, weights can be adjusted as
6. In this method, the weights cannot be adjusted frequently as possible. This helps in calculating
frequently. many kinds of index numbers.

7. These indices are very simple to understand. 7. These indices are difficult to understand.

8. Even if the index of one period is missing, 8. If the index of one period is missing, then
problem will not arised. subsequent chain indies cannot be computed.

Cost of Living Index Numbers: The cost of living index numbers are designed to measure the average
increase in the cost of the commodities consumed by a class of people i.e., cost of maintaining the same
standard in a given year as compared in the base year i.e., cost of living index numbers study the effect of
changes in prices of different types of goods and services purchased by a particular class of people during
a given year as compared in the base year.

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Main steps in the Construction of Cost of Living Index Numbers: The following are the main steps
involved in the construction of cost of living index numbers.

1. Scope and Coverage: The first step is to decide and select a group or class of people for which the
index number is to be constructed. The class of people means whether low income group, middle income
group, high income group, industrial workers, agricultural labour, government employees etc. Secondly,
we have to choose a geographical region of the selected group of people such as city or rural villages or
urban localities or industrial area or hilly area etc. A class of people is selected in such a way that it should
form a homogeneous group with respect to income.

2. Family Budget Enquiry: The next important step is to conduct a family budget enquiry. The enquiry
should involve a reasonably adequate number of families and should be conducted in a normal period i.e.,
a period free from economic depression. The main objective of the enquiry is to determine the amount on
an average family spends on different commodities of consumption. The various commodities of family
budget enquiry can be broadly classified into the following five major groups.

1. Food, Clothing, Fuel and Lighting, House Rent, Miscellaneous

2. Each of these groups may be further subdivided into smaller subgroups. For
example, food may be sub-divided into Wheat, Rice, Pulses etc. The group
miscellaneous may be sub-divided into education, medical care, recreation, gifts etc.

3. Selection of Commodities: Another important aspect is selection of the commodities, which are used
by the respective class of people only should be included. It should represent the habits, tastes and
customs of the group of people.

4. Collection of Retail Prices: The collection of retail prices of the various commodities is very
difficult and time consuming, the reason for this is the retail prices vary from place to place, shop to
shop and person to person. All the price quotations should be obtained from most reliable sources like
super bazaars, fair price shops and departmental stores where the respective group of people reside and
purchase the commodities.

Methods of Constructing the Cost of Living Index Numbers: The following are two methods used in
the construction of Cost of Living Index numbers.

1. Aggregate Expenditure Method: In this method, the weights are considered as the quantities of various
commodities consumed in the base year. The cost of living index number in this method is expressed as
the aggregate expenditure obtained with current year price as a percentage of aggregate expenditure
obtained with the base year prices.

Cost of living index number (C.L.I)=

p q ij oj
100
p q0j 0j

Aggregate exp enditurein current year

= 100
Aggregate exp enditurein base year

This is nothing but a Laspeyre’s price index formula and widely used in the construction of cost of
living index number.

2. Family Budget Method (or) the Method of Weighted Relatives: In this method, the cost of living index
number is obtained by using weighted averages of price relatives formula. The weights being considered
as values of quantities assumed in the base year. We consider the arithmetic mean of price relatives.

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 n  pij 
w 
j 
p0 j 
C.L.I . 
j 1  100 , where w j  p0 j q0 j
n

 wj
j 1

w p
j 1
j j
pij
or simply C.L.I .  n
, pj   100
w
p0 j
j
j 1

Uses of Cost of Living Index Numbers:

1. Cost of living index numbers are used in regulation of D.A. (Dearness allowance) to government
employees

2. These are used in the calculation of real wages from the money wages or nominal wages.

3. These are used in calculating the change in the purchasing power of the money.

Purchasing power of the money = 1/( Cost of living index number)

4. These are used widely in wage negotiations and wage contracts.

5. They are used in deflation of income and value series in national accounts.

Uses of Index Numbers:

1. Index numbers are used in the field of economy as indicators of inflationary or deflationary tendencies,
hence these are called economic barometers.

2. Index numbers are indispensable tools for the management personnel for business planning and
formulation of executive decisions.

3. Index numbers are useful to study the relative changes in the level of phenomenon at different periods of
time, these are specially useful for the study of the general trend in a time series data.

4. Index numbers are indispensable tools for any organization for making in efficient planning and
formulation of executive decisions.

5. The cost of living index numbers are most useful for regulating dearness allowance (D.A) and to grant
bonus to the government employees and industrial workers, etc.

6. The cost of living index numbers are most useful tools for calculating real wages from money wages,
wage negotiations and wage contracts, measuring purchasing power of money, deflation of income,
deflation of income, etc

Limitations of Index Numbers:

1. Since the data for constructing the index numbers are collected from the samples only. The errors
involved in the sampling procedures also occurred in the construction of index numbers. Hence index
numbers reflect only approximate changes in the relative level of phenomenon.

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2. At each stage of the construction of the index numbers, starting from selection of commodities to the
choice of formula there is likelihood of the error being introduced. As far as possible these errors should be
minimized.

3. Due to rapid change in customs and fashions of the customers index numbers may not be truly
representative of comparison of two time periods.

4. The various formulae used in the construction of index numbers is itself are subjected to limitation and
may not represent a true or accurate changes in the phenomenon.

5. Index numbers are special type of averages. Since the various averages (mean, median, geometric mean)
have their relative limitations their use may also introduce error in the construction of index numbers.

6. Bias in the selection of base year, selection of commodities and selection of price and quantity quotations
etc affects index numbers construction.

Additional Information

Base Shifting: Base shifting means constructing a new series of index numbers based on some new base
period or more recent base period for a given old series of index numbers based on some past or old base
period. Shifting of base period is needed in the following situations.

1. When the base period is too old or too different from the current period and comparisons are not
meaningful.

2. If two different series of index numbers are constructed with different base periods and if we want to
compare these series of index numbers, then to make a comparative analysis both the series must be
expressed with a common base period.

Formulae used for Base shifting:

First consider the index number of new base period is 100 and then we express the given series of
index numbers as a percentage of the index numbers of the time period selected. The series of index
numbers with new base year is calculated by using the following formula.

Index number of old base year

index number for any year  100
Index number of newbase year

100
If we consider the common factor (CF) as CF 
Index number of newbase year

then new series of index number is obtained by multiplying the old index number with a common factor.

Splicing of two index number series:

Splicing means combining or joining two or more overlapping series of index numbers to get a
continuous series with a common (or single) base period. This is very similar to base shifting.

Let us suppose a series of index number is calculated the based period ‘0’ and continued upto kth
period. The series was discontinued in the kth period due to some reasons and a new series of index numbers
is calculated with ‘k’ is the base period for the same commodities. These two series of index number must
be spliced with common base period.

Let the index numbers of two series as mentioned below in the table.

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Period First series of Index numbers base period - ‘0’ Second series of index numbers base period - ‘k’

0 100
1 a1
2 a2
: :
k 1 :
k ak 1
k 1 ak 100
k2 b1
: b2
: :
The two series may be spliced into the following two ways.

1. Forward Splicing:

If the second series is spliced to first series with the base period’0’ is known as forward splicing.
In this procedure first series indices will be remain same and second series of index numbers are to be newly
ak
constructed. For this, multiply each of the second series indices with a constant factor (CF) , we get
100
the new series of index numbers which are spliced to first series with base period ‘0’.

2. Backward Splicing:
If the first series is spliced to second series with the base period ‘k’ is known as backward splicing.
In this procedure second series indices will be unaltered and the first series of index numbers are to be
ak
newly constructed. For this, multiply each of the first series indices with a constant factor (CF) , we
100
get new series of indices wich are spliced to second series with base period ‘k’. The forward splicing
and backward splicing can be easily explain in the following table:

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Year First series of Second splicing (base –‘0’) Forward splicing (base Backward splicing (base
index numbers second series spliced to first – ‘0’) second series – ‘k’) first series spliced
base – ‘0’ series spliced to first series to second series
0 100 100 100
 100
ak

1 a1 a1 100
 a1
ak

2 a2 a2 100
 a2
ak

: : : :

k 1 ak 1 ak 1 100
 ak 1
ak

k ak 100 ak 100

k 1 b1 ak b1
 b1
100

k 2 b2 ak b2
 b2
100

k 3 b3 ak b3
 b3
100
: : :

Deflation of Index Numbers: Deflation refers downward adjustment of values due to rise in general price
levels (or) deflation means making allowance for the effect of changing price levels. In other words, the
process of removing the effect of price changes from the current money values is called deflation. Generally
the purchasing power of the consumer will be reduced over a period of years if the prices of consumer
goods are increased.

For example, the price of a commodity increased from Rs. 10 in a particular base year to Rs. 20 in
the given current year. This implies that in the current year, the person can purchase only half the amount
of the commodity with Rs. 10 which he spent in base year i.e., the purchasing power of a rupee is only 50
paise in the current year as compared to base year.

The purchasing power of money is obtained by the reciprocal of price index number and
consequently the real income or real wage is obtained by dividing the money or nominal income by the
corresponding price index number and multiplying this result by 100.

Money wage(or ) No min al wage

i.e., Real income or real wage  100
Pr ice Index number

This real income is known as deflated income.

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Wholesale Price Index Numbers:

Brief history in India: The wholesale price index numbers indicate all transactions at first point of bulk
sale in the domestic market. This index reflects adequately the current structure of economy. The wholesale
price index number in India was constructed by the Office of the Economic Advisor, The Ministry of
Commerce and Industry. The first of its construction was in January, 1947 with 1939 as the base year.
Whole sale price indices will be revised once in a decade. Six revisions have taken place with the new base
years 1952 -53, 1961- 62, 1970-71, 1981-82, 1993-94 and 2004-05. Presently, the Whole sale price indices
are calculated for the year 2013 are constructing on the basis of 2004-05.

The Construction of Wholesale price Index Number: The Construction of Whole sale price Index
Number in India was briefly discussed below.

Around on every Friday, the office of the Economic Advisor collects the weekly price quotations
of various commodities. Then the commodity indices will be obtained by using simple arithmetic mean of
price relatives. Later by using weighted arithmetic mean of commodity indices, they obtain subgroup or
group indices. Finally, the general index or all commodity index was obtained by using weighted average
of price relatives based on arithmetic mean. These index numbers are called Whole sale price index numbers
which will be published weekly by the Economic advisor. Then monthly indices will be obtained by using
arithmetic mean of weekly indices and finally the annual indices will be obtained by using arithmetic mean
of monthly indices.

The wholesale price index (WPI) numbers are calculated by the weighted averages of price relatives
by taking weights as items in the base year. i.e., according to Laspeyre’s formula.

WPI 
I W j j
, where I j =index number of the jth item, W j =weight assigned to jth item.
W j

The Whole sale price Index Numbers are usually constructed with three major groups which further
divided into subgroups and sub – groups consists of various number of commodities.

The major groups are

1. Primary articles

2. Fuel and Power

3. Manufactured products

1. Primary articles: This group consists of three major subgroups i.e., food articles, non – food articles
and minerals. Food articles include food grains, cereals and pulses, fruits and vegetables, milk, eggs, meat,
fish, condiments and spices and various other food articles. Non – food articles include fibers, oil seeds.
Minerals include metallic minerals and other minerals.

2. Fuel and Power: This group has three subgroups coal mining, mineral oil and electricity.

3. Manufactured products: This group has the following subgroups

1. Food products, 2. Beverages, tobacco products, 3. Textiles, 4. Wood and wood products, 5. Paper and
Paper products, 6. Leather and Leather products, 7. Rubber and Plastic products, 8. Chemicals and Chemical
products, 9. Non – metallic mineral products 10. Basic metals, alloys and metal products, 11. Machinary
and machine products, 12. Transport equipment and parts, 13. Other industries.

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