Index Numbers
Prof. Dr. M. O. Wankhade
Dept. of Statistics
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Index Number
Introduction:
Index numbers are devices for measuring changes in the magnitude
of a group of related variables, over a period of time.
These changes may have to do with the prices of the commodities,
the physical quantity, changes of goods produced, marketed or
consumed, or such concepts as intelligence beauty, or efficiency.
The comparisons may be between periods of time, between places,
between like categories such as persons, schools, or objects.
Thus, we may have index numbers comparing the cost of living at
different times or in different countries or localities, the physical
volume of production in different factories, or the efficiency of
different school systems.
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An index number is an aggregate measure of the relative change in
a collection of presumably related items.
For example, a price index is an attempt to consider a particular
market basket of commodities and services, the prices for each item
in that market basket at two points of time, the relative importance
of each item in the market basket, and to put all that information
together in such a way that the general change in price for the total
(or aggregate) market basket can be represented by one number.
Index numbers are called as economic barometers.
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Definition of an index number
Index numbers are statistical devices designed to measure the
relative change in the level of a phenomenon with respect to time,
geographical location or other characteristics, such as incomes, level
of production etc.
Such a study is of great importance for understanding economy, for
the making of government policies and for fixing the wages etc.
As a matter of fact, the index number is an economic barometer as it
gives a measure of the economic pressure on the consumers, directly
or indirectly.
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John I. Griffin has described it as “An index number is a
quantity which by reference to a base period, shows by its
variation, the changes in the magnitude over a period of time.”
Index numbers are the numbers which express the value of a
variable at any time (current period) as a percentage of the
value of that variable at some reference period or base period.
Edgeworth defined index numbers as- “Index Number shows
by its variation the changes in a magnitude which is not
susceptible of either accurate measurement in itself or of direct
variation in practice”.
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Problems involved in computation of Price Index Number
The problems which the statistician encounters in index-
number construction are:-
1) The purpose of index number
2) Selection of commodities.
3) Data for index numbers.
4) Selection of base.
5) Type of average to be used.
6) Selection of appropriate weights.
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The purpose of index number
An index number properly designed for the purpose in
hand is a most useful and powerful tool.
If not properly compiled and constructed, it can be a
dangerous one.
If the purpose of index number is to measure changes in the
production of steel, say, the problem of selection of
commodities is automatically settled.
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Selection of commodities
After defining the purpose of index low-income the next step is selection of
the commodities to be included for calculation of index numbers.
Select only those commodities which are relevant to the calculation of
index number.
If the purpose of our index number is to measure the cost of living of low-
income group persons, we should select only those commodities which are
consumed or used by persons belonging to low-income group.
Commodities used by high income group should not be used for calculation
of index number in this case, for example cosmetics luxury items should
not be used for calculation of cost of living index number of low-income
group.
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Data for index numbers
The data for the construction of index numbers should be
collected from reliable sources such as standard journals, official
Publications, special report from the producers and exporters etc.
through field agencies.
For example for the construction of retail price index number the
price quotation should be obtained from Super Bazars, fare price
shops, departmental stores, etc. not from the wholesale dealers.
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Selection of base period
Below are given the major points for the selection of best
period
1. The base period should be normal.
2. The base period should not be too distant from the
given period
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Type of average to be used
Index numbers being the specialized averages, the choice of
average for the construction of index number has vital
importance.
Usually Arithmetic mean, Geometric mean, median may be used
for the construction of index numbers.
From the theoretical considerations Geometric mean is most
appropriate average for construction of index number but
Geometric mean is not used because of it's complicated
computations.
Arithmetic mean is usually used in the construction of index
numbers. 11
Selection of proper weights
Generally various items commodities say wheat, rice,
kerosene, clothing, etc. included in the index number are
not of equal importance.
Proper weights should be attached to these items to take
into account their relative importance.
There are two types of indices
1. Unweighted indices.
2. Weighted indices.
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Notations:
Before the discussion of constriction of index number, let us
explain the notation and terminology used.
pij = Price of jth commodity in ith year
qij = Quantity consumed of jth commodity in ith year.
vij = pij x qij = the value of jth commodity in ith year
j = 1, 2, , , n and i = 0, 1, 2, , , k
0- refers to the base year
i- refers to the given (current) year
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Construction of index numbers
Simple (unweighted) Aggregate method:
In this method aggregate of prices in any year is expressed as
the percentage of their aggregate in the base year.
The price index for ith year ( i= 1, 2, , ,k) as compared to
base year i = 0 is defined as;
The quantity index for ith year ( i= 1, 2, , ,k) as compared
to base year i = 0 is defined as;
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Drawbacks of Simple aggregate Method
The price of different commodities may be in different
units, e.g. per lit, per meter, per kg. etc
The relative importance of various commodities are
neglected.
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Example:- Compute Index number by Simple aggregate Method
Price
Commodities
2010 2022
Sugar 20 33
Soybean oil 70 140
Pulses (Tur) 83 98
Wheat 13 21
Rice 30 42
Sum 216 334
∑p0j ∑pij
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Weighted Aggregate method:
In this method appropriate weights are assigned to each of the
commodities.
The weighted Aggregate price index is defined as;
Where wj (quantity consumed) is the weight associated with
jth commodity.
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Laspeyre’s Price Index or Base Year Method:
French economist Laspeyere in 1871, suggested that
quantities of commodities consumed in base year are taken
as weights for the purpose of calculating index numbers.
Laspeyre’s Price Index is defined as
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Paasche’s Price Index (or Given Year) Method :
In this method given year quantities are taken as weights
for the purpose of calculating index numbers. i.e.
Paasche’s Price Index is defined as;
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Dorbish-Bowley Price Index Number:
Dorbish-Bowley Price Index Number is the arithmetic mean of
Laspeyre’s and Paasche’s indices and is given as follows;
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Marshall – Edgeworth Price Index
(or Base and Given Year) Method:
In this method weights wj are taken as the arithmetic mean of
base and given year quantities, i.e.
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Walsch Price Index Number
In this index number weights are taken as geometric mean of the
base year and current year quantities. i.e.
Therefore, Walsch Index number is;
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Irving Fisher’s Index Number
Fisher’s index number is the geometric mean of the
Laspeyre's and Paasche’s formula.
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Compute Laspeyre’s Index number
2010 2022 Lasp
Price Quantity Price Quantity
Commodities pij*qoj poj*qoj
p0j q0j pij qij
Sugar 20 5 33 7 165 100
Soybean oil 70 3 140 4 420 210
Pulses (Tur) 83 3 98 4 294 249
Wheat 13 15 21 14 315 195
Rice 30 10 42 14 420 300
Sum 1614 1054
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Compute Paasche’s Index number
2010 2022 Paasches
Price Quantity Price Quantity
Commodities pij*qij p0j*qij
p0j q0j pij qij
Sugar 20 5 33 7 231 140
Soybean oil 70 3 140 4 560 280
Pulses (Tur) 83 3 98 4 392 332
Wheat 13 15 21 14 294 182
Rice 30 10 42 14 588 420
Sum 2065 1354
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