Index numbers

Presentation
by
A M Kambugu
introduction
 Historically, the first index was constructed
in 1764 to compare the Italian price index
in 175o with price level in 1500
 index numbers provide a standard way of
comparing the values, over time, of prices,
wages, volume of output and so on
 they are used extensively in business,
government and commerce
 index numbers have become today today
one of the most widely used statistical
devices
 Newspapers headline the fact that prices
are going up or down, that industrial
production is rising or falling, that imports
are increasing or decreasing, that crimes
are rising in a particular period compared
to the previous period as disclosed by
index numbers.
 They are used to feel the pulse of the
economy and barometers of economic
[Link] of index numbers are
Nairobi share index,USE share index etc
Index number definition
 are devices for measuring
differences in magnitude of a group
of related variables-Croxton&
Cowden
 is a statistical measure designed to
show changes in a variable or a
group of related variables with
respect to time, geographic location
or other characteristics such as
income , profession , etc-spiegel
 is the ratio of two numbers
expressed as per centage-Patterson
continuation
 In its simplest form, an index number is
nothing more than a relative number or
relative”which expresses the
relationship between two figures, where
one of the figures is used as a base-
Morris Hamburg
 it is clear from the above definitions that an
index number is a specialised average
designed to measure the change in a group
of related variables over a period of time
 Thus when we say that index number of
wholesale prices is 112 for APRIL 2004
compared to April 2003 it means there
is a net increase in the prices of
wholesale commodities to the extent of
12% during the year.
 Index numbers, in effect relate a
variable or variables in a given period to
the same variable or variables in
another period, called the base period
Index numbers-tools of
economic and business
analysis
 They help in framing suitable [Link]
deciding increase in dearness allowance of
the employees, the employers have to
depend primarily upon the cost of living
index
 they reveal trends and tendencies
 index numbers are very useful in deflating.
: ie they are used to adjust the original
data for price changes, or to adjust wages
continuation
 for cost of living changes.
Classification of index
numbers
 May be classified in terms of what they
measure.
 In economics and business the
classifications are: price, quantity, value
and special purpose
 a price index number: measures the
change in the money value of a group of
items over [Link] the best known
price index in Uganda is the consumer
prices index
continuation
 Which measures changes in the costs of
items of expenditure of the average
household.
 A quantity index[also called a volume
index] measures the change in the non-
monetary values of a group of items over
time. An example is a productivity index,
which measures changes in the
productivity of various departments or
groups of workers
Problems in the
construction of index
numbers
 The purpose of the index: the purpose of
constructing the index must be very clearly
decided-what the index is to measure and
why? There is no all purpose index. Every
index is of limited and particular use
 selection of a base [Link] base period
of an index number is the period against
which comparisons are [Link] may be a
year, month or a day. The selection will
depend
 of the base period would primarily depend
upon the object of the index, the following
points need careful consideration of the
base period: should be normal year, not too
distant in the past, fixed base./chain base
 Selection of the number of items
 obtain price quotations
 choice of averages
 selection of appropriate weights
 selection of an appropriate formula
Methods of constructing
index numbers
 a large number of formulae have been
devised for constructing index numbers.
 Broadly speaking, they can be grouped
under two heads
 unweighted indices; and
 weighted indices
 in the unweighted indices weights are
not expressly assigned and whereas in
the weighted indices weights are
assigned to the
continuation
 To the assigned to the various
items. Each of these types may be
further divided under two heads
 simple aggregate and
 simple average of relative
Simple aggregate method
 This is the simplest method of
constructing index numbers. When this
method is used to construct a pride
index the total of current year prices for
the various commodities in question is
divided by the total of base year prices
and the quotient is multiplied by 100
 this method of constructing the index is
the simplest of all the methods.
 The steps required in computation
are
 add the current year prices for
various commodities, ie obtain Σp1
 add the base year prices for the same
commodities, ie , obtainΣpo
 divide Σp1byΣpo and multiply the
quotient by 100
Limitations of this index
 There are two main limitations of
the simple aggregate index
 the units used in the price or
quantity quotations can exert a big
influence on the value of the index
 no consideration is given to the
relative importance of the
commodities
Simple average of price
relative method
 When this method is used to construct a
price index, first of all price relatives are
obtained for the various items included in
the index and then average of these
relatives is obtained using any one of the
measures of central value ie arithmetic
mean, median, mode, geometric mean or
harmonic.
 When arithmetic mean is used for
averaging the relatives
Weighted index numbers
 They assign equal importance to all to all
the items included in the index and as
such they are in reality weighted, weights
being implicit rather than explicit.
 construction of useful index numbers
requires a conscious effort to assign to
each commodity a weight in accordance
with its importance in the total
phenomenon that the index is supposed to
describe
 Weighted index numbers are two types:
 weighted aggregative indices and
 weighted average of relatives indices
 weighted aggregative index numbers: these
indices are of the simple aggregative type with
the fundamental difference that weights are
assigned to the various items included in the
index
 there are various methods of assigning weights
and consequently a large number of formulae
for constructing index numbers have been
devised of which some of the
 the more important one are:
 Laspeyres method
 Paasche method
 Fisher`s ideal method
 all these methods are named after
the persons who have suggested
them
 Laspeyres Method: the Laspeyres
Price Index is a weighted aggregate
price index, where the weights are
quantities in the base period
 Paasche [Link] price
index is a weighted aggregate
price index in which the weights
are determined by quantities in the
current year
Comparison of Laspeyres
and Paasche methods
 Laspeyres index measures change in a
fixed market basket of goods and services
 the same quantities are used in each
period
 Paasche index continually updates the
quantities to the levels of current
consumption
 the two approaches tend to produce
opposite extremes in index values
computed from the same data