Meaning and Characteristics of Index Numbers

An index number is a method of evaluating variations in a variable or group of variables in regards to the geographical location, time, and other features. The base value of the index number is usually 100, which indicates price, date, a level of production, and more.

There are various kinds of index numbers. However, at present, the most relatable is the price index number that particularly indicates the changes in overall price level (or in the value of money) for a particular time.

Here, the value of money is not constant, even if it falls or rises it will affect and change the price level. An increase in the price level determines a decline in the value of money. A decrease in the price level means an increase in the value of money.

Therefore, the differences in the value of money are indicated by the differences in the overall price level for a particular time. Therefore, the changes in the overall prices can be evaluated by a statistical device known as ‘index number.’

Types of Index Numbers

Price index number: It evaluates the relative differences in costs between two particular points in time.

Quantity index number: It measures the differences in the physical quantity of the product’s manufacturing, buying, or selling of one item or a group of items.

Index Numbers: meaning and characteristics

(A) Definition of index numbers According to Croxton and Cowden, the index numbers are devices for measuring differences in the magnitude of a group of related variables.

    According to Spiegal, an index number is a statistical measure designed to show changes in a variable or a group of related variables with respect to time, geographical locations, or other characteristics.

(B) Following are the important characteristics of index numbers.
(1) Expressed in

percentage

A change in terms of the absolute values may not be comparable.

Index numbers are expressed in percentage, so they remove this barrier. Although, we do not use the percentage sign.

    It is possible to compare the agricultural production and industrial production and at the same time being expressed in percentage, we can also compare the change in prices of different commodities.

(2) Relative measures or measures of net changes Index numbers measure a net or relative change in a variable or a group of variables.

    For example, if the price of a certain commodity rises from ₹10 in the year 2007 to ₹15 in the year 2017, the price index number will be 150 showing that there is a 50% increase in the prices over this period.

(3) Measure change over a period of time or in two or more places Index numbers measure the net change among the related variables over a period of time or at two or more places.

    For example, change in prices, production, and more, over the two periods or at two places.

(4) Specialised average Simple averages like, mean, median, mode, and more can be used to compare the variables having similar units.

Index numbers are specialised average, expressed in percentage, and help in measuring and comparing the change in those variables that are expressed in different units.

    For example, we can compare the change in the production of industrial goods and agricultural goods.

(5) Measuring changes that are not directly measurable Cost of living, business activity, and more are complex things that are not directly measurable.

    With the help of index numbers, it is possible to study the relative changes in such phenomena.

 

What are the advantages of index numbers?
Answer
Index numbers are one of the most widely used statistical tools. Some of the advantages or uses of index numbers are as follows:
(1) Help in formulating policies Most of the economic and business decisions and policies are guided by the index numbers.

Example:

To increase DA, the government refers to the cost-of-living index.

    To make any policy related to the industrial or agricultural production, the government refers to their respective index numbers.

(2) Help in study of trends     Index numbers help in the study of trends in variables like, export-import, industrial and agricultural production, share prices, and more.
(3) Helpful in forecasting     Index numbers not only help in the study of past and present behaviour, they are also used for forecasting economic and business activities.
(4) Facilitates comparative study To make comparisons with respect to time and place especially where units are different, index numbers prove to be very useful.

    For example, change in ‘industrial production’ can be compared with change in ‘agricultural production’ with the help of index numbers.

(5) Measurement of purchasing power of money to maintain standard of living Index numbers, such as cost inflation index help in measuring the purchasing power of money at different times between different regions.

    Such analysis helps the government to frame suitable policies for maintaining or raising the standard of living of the people.

(6) Act as economic barometer     Index numbers are very useful in knowing the level of economic and business activities of a country. So, these are rightly known as economic barometers.

 

Q. 1 Briefly discuss the problems involved in the construction of index numbers.
Answer:
Following are some of the problems involved in the construction of index numbers:
(1) Purpose of index numbers Many different types of index numbers are constructed with different objectives.

Example: Price index, quantity index, consumer price index, wholesale price index, and more

    So, the first important issue/problem is to define the objective for which the index number is to be constructed.

(2) Selection of base period Base period is the period against which the comparisons are made.

Selection of a suitable base period is a very crucial step.

It should be of reasonable length and normal one, i.e., it should not be affected by any abnormalities like, natural calamities, war, extreme business cycle situations.

    It should neither be too close nor too far.

(3) Selection of commodities All the items cannot be included in the construction of an index number.

Nature and number of items to be included in an index number depends upon the type of index to be constructed.

    For example, to construct a ‘consumer price index’ those commodities should be considered that are generally consumed and the number should be neither too small nor too big.

(4) Selection of sources of data Depending upon the type of index numbers, the correct source should be selected for data.

    Like, to construct CPI, we need retail prices and to construct the wholesale price index, we need wholesale prices. Accordingly, the right and reliable source should be selected.

(5) Selection of weights The term ‘weight’ refers to the relative importance of different items in the construction of index numbers.

All the items do not have the same importance.

    So, it is necessary to adopt some suitable measures to assign weight.

(6) Selection of an appropriate formula There are various formulas for construction of index numbers like Laspeyres’ method, Paasche’s method, Fisher’s method, and more.

No single formula is appropriate for all types of index numbers.

    The choice of formula depends upon the purpose of the available data.

 

Q.2 What is the consumer price index number? Give the uses of the consumer price index number.
Answer:
(A) Consumer price index number Consumer price index (CPI) measures changes in the cost of living due to changes in the retail prices of a basket of goods over a period of time.

Separate cost of living index is prepared for different classes of people.

    It is also known as the cost of living index numbers or retail price index number.

(B) Following are the uses of consumer price index number:
(1) Helpful in measuring the purchasing power of money Consumer price index has an inverse relation with the purchasing power of money.

Purchasing power of money = 1/Consumer price index

    As CPI increases, the purchasing power of money decreases.

(2) Helpful in wage negotiations CPI helps in determining wages for a particular class.

    It provides the basis for wage negotiations between the workers and employers.

(3) Help government in framing policies     These index numbers provide guidelines for the formulation of wage policy, price policy, taxation policy, and other general economic policies.
(4) Market analysis     CPI also helps a market analyst to determine the demand for different goods and services.
(5) Help businessmen in forecasting     On the basis of CPI of different classes of people, a businessman can make predictions about the demand for his products.

 

Q.3 Give the meaning of wholesale price index numbers. What is the utility of wholesale price index numbers?
Answer:
(A) Meaning of wholesale price index (WPI) Wholesale price index measures the changes in the wholesale prices of the commodities.

It indicates the change in general price level in the economy.

In India, it is prepared on a weekly basis.

    These days 2004-05 is considered as the base year

(B) Utility of wholesale price index (WPI)
(1) Indicator of inflation Inflation is a persistent rise in the general price level.

    WPI is used to determine the rate of inflation in an economy.

(2) Forecasting demand and supply It is often used to forecast demand and supply situations in the economy.

An increase in WPI indicates a situation of excess demand over supply of goods.

    A decrease in WPI indicates a situation of excess supply of goods.

(3) Helps in determining real changes in aggregates WPI helps us to find out the real changes in aggregates like national income, national expenditure, and more.

    Using WPI of the current year and the base year, we can convert national income at current prices into national income at constant prices.

(4) Cost of projects It determines the future cost of long-run[1]  projects.

If WPI has an increasing trend, it will result in an increase in prices of various goods used in the projects.

    As a result the cost of such a project will go up.

 

Q.4 What are the major limitations of index numbers?
Answer:
Following are the major limitations of index numbers:
(1) Difficulty in construction of index numbers     The decision of objective, selection of base period, selection of commodities, selection of sources of data, selection of ‘weights’, selection of formula, and more are the several difficulties in the construction of index numbers.
(2) Based on sample items, so only approximate indicators     Index numbers are generally based on a few sample items. So, the results derived are approximate and not perfect.
(3) Ignores quality of commodities These days the quality changes occur very fast and the index numbers ignore this aspect.

    So, the results shown by these may not be appropriate.

(4) Limited use There is no ‘master index number’ or ‘all in one index number’.

    Use of each index number is restricted to its specific object.

(5) Useful only for short-term comparison Over a period of time, rapid changes occur in habits, tastes, preferences, and more.

    So,the index number constructed in the present may not be comparable with the one constructed a few years back.

Multiple Choice Questions

Q.1 According to ______________,  the index numbers are devices for measuring differences in the magnitude of a group of related variables.
a. Spiegel

b. Croxton and Cowden

c. Both (a) and (b)

d. None of the above

Q.2 Which of the following is the characteristic of an index number?
a. Measure change over a period of time or in two or more places

b. Specialised average

c. Expressed in percentage

d. All of the above

Q.3 Index numbers measure a net or relative change in a variable or a group of variables.
a. Absolute

b. Relative

c. Both (a) and (b)

d. None of the above

The concept mentioned is elucidated in detail about the ‘correlation’ for the class 11 commerce students. To know more about such concepts, stay tuned to BYJU’S.

 

2 Comments

  1. Sir it is very usefull for economics and other subject student

  2. Amazing. Everything is explained in an understandable point-wise manner. Precise important points

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