Index Numbers

Q1: What is meant by index numbers?

An index number is a statistical device for measuring changes in the magnitude of a group of related variables. It
represents the general trend of diverging ratios, from which it is calculated. Price index numbers measure and
permit comparison of the prices of certain goods. Quantity index numbers measure the changes in the physical
volume of production, construction or employment.
According to Croxton and Cowden, “Index numbers are devices for measuring differences in the magnitude of a
group of related variables”
According to Spiegel “An index number is a statistical measure designed to show changes in variables or a group of
related variables with respect to time, geographic location or other characteristics.

Q2: What is the Importance of Index Number?

1. As economic barometer: Index numbers act as economic barometer and are used to feel the pulse of
economy and serve as indicators of inflationary or deflationary tendencies. They are therefore used to
formulate policies. As the barometer measure pressure for weather of a geographical area, index numbers
measure prices which determine the economic conditions and performance of an economy.
2. Help in study of trends: Index numbers are very useful in studying the trend or tendency of a series over a
period of time. It is easy to find out the trend of exports, imports, balance of payments, industrial
production, prices, national income and variety of other phenomena. It is also useful in forecasting future
trends.
3. Measurement of change in the price level or value of money – Index numbers measure the value of money
during different periods of time. This measure is used to assess the impact of the change in the value of
money on different sections of the society. Accordingly policies may be framed to correct inflationary or
deflationary gaps in the system.
4. Knowledge in the change in the standard of living – Index numbers help to ascertain the change in standard
of living. Money incomes may increase but if index numbers show a decrease in the value of money, living
standards decline. Thus, index numbers indicate change in real income.
5. Adjustments in Salaries and Allowances – Cots of living index is a guide to the Government and private
enterprises to make necessary adjustments in salaries and allowances of workers. Increase in cost of living
suggests increase in salaries and allowances.
6. Information regarding production – Index numbers show whether the level of agricultural and industrial
production in the economy is increasing or decreasing. Accordingly agricultural and industrial development
policies are formulated.
7. Useful to politicians – Politicians come to know of the real economic condition of the country on the basis of
index numbers. They offer constructive criticism on economic policies and give suggestions
8. Useful to Government – Government uses index numbers to determine its monetary and fiscal policies and
takes concrete steps for economic development. It helps the government to formulate appropriate policies
to increase investment, output, income employment etc.

Q3. What are the methods of constructing an index number?

A) Simple Index numbers -
 Simple Aggregative Method - (∑p1/∑p0)*100
 Simple Average of Price Relative Method - (∑ (p1/p0) *100)/N
B) Weighted Index Numbers – Laspeyre’s Method & Paasche’s Method
Laspeyre’s Method
Mr. Laspeyre in 1871 gave as weighted aggregated index, in which weights are represented by the quantities of
the commodities in the base year.

 Formula:

Paasche’s Method
The German statistician Paasche in 1874 constructed an index number, in which weights are determined by
quantities in the given year.
  Formula:

Q4. Write a short note on consumer price index, wholesale price index and index of industrial production.
A) Consumer Price Index –Consumer price index (CPI), also known as the cost of living index, measures the average
change in retail prices. The CPI for industrial workers is increasingly considered the appropriate indicator of
general inflation by most of the countries, because it shows the most accurate impact of price rise on the cost of
living of common people. They are calculated every month to analyse the impact of changes in the retail price on
the cost of living of these three broad categories of consumer. In this index, food has the largest weight. Food
being the most important category, any rise in the food price will have a significant impact on CPI. This also
explains the government’s frequent statement that oil price hike will not be inflationary.
Methods of Constructing CPI
The consumer price index numbers are constructed by the following two methods:
(i) Aggregate Expenditure Method or Weighted Aggregate Method;
(ii) Family Budget Method or Method of Weighted Average of Price Relatives
Aggregate expenditure Method
This method is similar to the Laspeyre’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 (base and current) is calculated.

Consumer Price Index

Family Budget Method
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.

Consumer Price Index

B) Wholesale Price Index - The wholesale price index number indicates the relative changes in the prices of
commodities traded in the wholesale market. In India, the wholesale price index is calculated on a weekly basis.
Whole sale prices indices are used to forecast demand and supply situation in the economy. An increase in the
wholesale price index is also used to calculate the rate of inflation in the country.
In India, all commodities have been classified in the following 3 groups –
Commodity Group Name of Commodities Weightage
Primary Articles This includes 98 commodities like Rice, Fruits, 22.02
Pulses, Vegetables and non-food articles like
Cotton , Jute, metals
Fuel, Power, Light and These include 19 items like Coal, Petroleum 14.23
Lubricants Products , Electricity, LPG
Manufacturing It includes 318 items like Textile, Sugar, Paper, 63.75
Machinery, Chemicals, Fertilisers, Leather etc.

C) Index Number of Industrial Production (IIP) - Index number of industrial production is that index which measures
the relative increase or decrease in the level of industrial output of a country in comparison to the level of
production in the base year. It tells us about the quantum of production and is useful in estimating the growth of
industrial production in the economy. Index numbers of industrial production are fairly common these days.
They are the best measures of economic progress in any country. These indices can be constructed by studying
variations in the level of industrial output. Index numbers throw light of changes in the quantum of production,
and not in values. If the variation in the value of output is to be studied, data about the value of industrial output
have to be used for the purpose of constructing such index numbers. Thus indices of industrial production are
constructed either by studying changes in the quantum of production or its value.
 Index Number of Industrial Production

Q5. Explain the Steps in Construction of Index Numbers?

a) Purpose of Index Numbers – Every index has a limited and specific use or purpose. So first step in
construction is to carefully define and decide the purpose of its construction
b) Selection of Base Year –
 The base period is associated with an index number is a period of time that is used as a basis for
comparing changes in prices or quantities in a given period.
 The base period should be a normal one. It should be free from all sorts of abnormalities and
irregular fluctuations like wars, floods, famines etc.
 The difference between base year and current years should not be too large.
 Fixed Base or chain Base – The selection of fixed base or chain based method depends on the
purpose of construction of index number.
c) Selection of number of items or commodities – The number of items to be included should be
determined by the purpose for which the index number is constructed. The commodities selected should
be representative and the total number of items should not to be too small or too large.
d) Selection of sources of data – The data is scattered over large area so there are chances for its being
misleading. The data should be reliable, accurate and comparable.
e) Price quotations – Price of commodities vary from place to place. Therefore data should be collected
from all places. The places which are well known for trading of that particular commodity should be
selected for obtaining price quotation.
f) Selection of the Averages – Different types of averages such as arithmetic mean, mode, median,
geometric mean etc. can be used in preparing index numbers.
g) Selection of appropriate weights – The term weight refers to the relative importance of different items.
The weights can be either weights or value weights.
h) Selection of an appropriate formula – Various formulas has been devised by statisticians for constructing
index numbers. The choice of formula would depend on purpose and also on the data available.
Q6. What is Sensex?
Sensex – This is a useful guide for the investors in the stock market. It is an index which is constructed with the
help of the prices of 30 important shares. If the Sensex is rising, investors are optimistic about the future
performance of the economy and decide an appropriate time for investment. As the share prices increase,
reflected by the rise in Sensex, the value of wealth of the shareholders also rises. The fall in Sensex shows that
all is not well with the health of the economy. The investors may find it hard to decide whether to invest or not.
Sensex also helps to determine the flow of FDI into the country.
Uses of Consumer Price Index – Consumer price index numbers are used to determine the purchasing power of
money and for calculating the real wages (income) from nominal or money wages (income). Consumer price
index is called price deflator of income.

Purchase Power of Money = 1/ consumer price index

Real wages = (Money wages/ Consumer price index)* 100

Q7. The money wage of an industrial worker is 2012-13 was Rs 3250 per month which was raised to Rs 5000 in
[Link] price index was 100 in2012-13 and for 2016-17 was 400. Calculate the real wage of the
workers in2016-17.
Formula- Money wage /Index * 100 = Real Wage
5000/400 *100 = 1250
Rs 1250 is the real wage for 2016-17.