Chapter 10

Index Number
Q: What is Index Number?
Ans: Index numbers are an important tool in Statistics and are widely used to understand the
health of an economy. Initially, they were created to study changes in prices. Nowadays, they
are used for various purposes like measuring the cost of living, industrial production,
agricultural output, and trade activities like imports and exports. Index numbers help show
percentage changes in one or more things over a specific period.

“An index number is a statistical tool used to track changes in a single variable or a set of
related variables.”

Q: Write down the features of Index Number.

Ans: The various features of Index Numbers are as follows:

1. Specialized Averages: To compare two or more series, averages like mean, median and
mode can be used. But averages cannot be used for comparison when series are composed of
different types of items, or if two or more series are expressed in different units. Index
numbers enable comparing changes in series.

2. Expressed in Percentages: The magnitude of a group’s changes is expressed in terms of

percentages, which are independent of the measurement units. It helps in figuring out how
two or more index numbers compare in various circumstances. Although, the percentage sign
is never used.

3. It assesses the impact of changes with respect to time or location: To compare changes
over time, between places, and within categories, index numbers can be used. For
example, the cost of living in two locations may differ at the same time, or the cost of living
in one city can be compared over two time periods.

4. It measures the change that cannot be measured directly: Its purpose is to

examine changes in the effect of such factors that cannot be observed directly. For
example, the cost of living cannot be measured directly. We can only study relative changes
by examining variations in some related external factors.

Q: Write down the uses of Index Number.

Ans:
1. Measurement and Comparison of Changes in the Price Level:

Index numbers provide a relative measure to the changes in the magnitude of variables. It can
be used to know the influence of changes in the value of money on different sections of
society. It is possible to solve the problem of inflation or deflation in the system.

2. Helps in Policy Formulation:

An index number is an important tool for government or non-government organizations in the

following ways:

 In policy formulation, there is a need for a base or trend. With the index numbers, the
trends of different phenomena can be studied.

 It can also be utilized in the formulation and planning of government and business
policies.

3. Acts as an Economic Barometer:

A barometer is an instrument that is used to measure atmospheric pressure. It indicates

fluctuations in the general conditions of a country and measures the pulse of the economy.

4. Helps in Studying Trade:

Index numbers are useful in studying the trend of a series over a period. It helps in
forecasting future trends which is crucial for any business or production activity's future
operations.

5. Measure Purchasing Power:

Money's worth is determined by purchasing power, and purchasing power is determined by

commodity prices. Index numbers help find the intrinsic value of money as contrasted with
its nominal value. It helps in establishing the nation's wage policy. Besides, a change in the
price of the commodity adversely affects the value of money. When the price level of a
commodity rises, the purchasing power or value of money falls.

Q: What are the different types of Index Number?

Ans: The types of index numbers are as follows:

1. Price Index Number: It measures the general changes in prices of goods. It compares
the level of prices between two different time periods.
 2. Quantity Index Number: It measures the changes in the level of output oy physical
volume of production in the economy. It is also called volume index number.
3. Value Index Number: The value of a commodity is the product of its price and
quantity (p × q). Value index number measure changes in the value of a variable in
terms of rupee. It is a more informative index as it combines both, changes in the
price as well as quantity.
4. Special Purpose Index Number: They are constructed with some specific purpose.
For example, import-export index numbers, labour productivity index numbers, share
price index numbers, etc.

Q: Write down the problems in the construction of index number.

Ans: The production of index numbers is fraught with challenges. Following are the
difficulties faced in the Construction of Index Numbers –

1. Difficulties in Choosing a Base Period: The first challenge is determining which year to
use as the starting point. The foundation year must be standard. However, determining a
causal year is tough. Furthermore, a typical year now becomes abnormal after a certain
amount of time. As a result, having the same base period for several years is not
recommended.

2. Problem in Commodity Selection: Another challenge is selecting the index number’s

representative commodities. The selection is not a simple task. They must be chosen from a
diverse range of things that are consumed. Consumer consumption patterns may change,
rendering the number of indexes obsolete. As a result, selecting representative commodities
involves significant challenges.

4. Difficulty in Choosing a Statistical Approach: Another challenge is deciding on a

suitable approach for calculating averages. However, each strategy produces a unique set of
findings. As a result, deciding which strategy to use is challenging.

5. It is not possible to make comparisons between different locations: Even if various

locations within a country are chosen, the same index number cannot be assigned to them.
This is due to variances in people’s consumption habits. Individuals in the northern part of
India consume different commodities than people in the southern portion of India. As a result,
applying the same index number to both is incorrect.
6. Not Appropriate to Individuals: An index number is not applicable to a single person
who is a member of the group it was created. A person may not be affected if there is a rise in
the price level index number shows. This is since an index number reflects averages.

Q: What is Consumer Price Index (CPI)?

Ans: 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.

Q: Write down the methods of constructing consumer price index number.

Ans: 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 like Laspeyre's Method of

Constructing Weighted Index. For the application of this method, one must estimate
the quantities of commodities consumed by the 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.
Consumer Price Index=∑p1q0 / ∑p0q0 ×100
2. Family Budget Method: This method involves carefully studying the family budgets
of many 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.
Consumer Price Index=∑RW / ∑W

Q: ‘Index Numbers are Economic Barometers’- Explain.

Ans: Index numbers are economic barometers. Index numbers measure the level of business
and economic activities and are therefore helpful in gauging the economic status of the
country. Index number is a special type of average that helps to measure the economic
fluctuations on price level, money, market, economic cycle like inflation deflation etc. It
helps the government by giving the percentage of change of prices of different commodities
with respect to a specified base year (any previous year whose economic activity is ideal) and
current year and thus helping the government for changing the policies or regulating new
policies or measures to attain the stability. Hence, they are also known as economic
barometers and economic indicators since they help in understanding the changes in
economic conditions of the society.

Q: Why Fisher’s index number formula is called an ideal index number?

Ans: Fisher’s Method of calculating index number is considered an ideal method because of
the following reasons:

1. Fisher’s Method is based on variable weights.

2. While calculating index number it takes price and quantities of both the base year and
current year into consideration.

3. This method is based on Geometric Mean (GM), and GM is considered the best mean for
determining index number.

4. Lastly, Fisher’s Method satisfies both tests; i.e., Time Reversal Test and Factor Reversal
Test.