Index numbers are specialized averages which are designed to measure the relative change in the level of a phenomenon

with respect to time, geographic location or some other characteristics. The averages are used to compare two or more series of data provided these series are expressed in same units, if we want compare two series of data in which the items are expressed in different units, index numbers are useful. Originally the index numbers were developed for measuring the effective of changes in the price level. Index numbers are also known as Economic Barometer as it measures the pressure of an economy. (Barometer is an instrument which is used to measure the atmospheric pressure . Uses of Index numbers !. ". #. It helps the government in framing suitable policies. It helps in studying trends and tendencies. It is used in deflating and in calculating purchasing power of money.

Steps involved in the construction of index numbers $efining the purpose It is necessary to define the purpose of the index number. %he purpose of index number would help in deciding about the nature of the data to be collected, the choice of the base year, formula to be used etc.& these factors play a very important role in the construction of Index number. 'election of Base period It is the period of comparison. %he base period is the period of the normal and stable economic conditions. It should be free from abnormalities, random or irregular fluctuations like wars, earth(uakes, strikes, lockouts etc. %he base period should not be too far from the current period. If we are constructing price index number then the price of commodities in base year is considered as !)). $epending on the nature of the data either fixed base or chain base is used. 'election of number of items *very item can+t be included while constructing the index number and hence one has to select a sample. %he commodities should be selected in such a way that they are representative of tastes, habits and customs of the people to whom the index is meant. It is also necessary to decide the grade or the (uality of the item that should be included in the sample. %he sample should be as large as possible. $ifferent commodities are available in the market& a decision has to be made which variety should be included in the sample. Obtaining the price (uotations ,fter selecting the items the next step is to obtain the price (uotations for the selected commodities. It is known that the price of the commodity is varies from place to place. %he prices should be collected from different places and then they have to be averaged and average price is considered for the construction of index number. -enerally price (uotations are collected from the places where the commodities are bought and sold in large (uantities. $epending upon the nature of the index numbers either wholesale prices or retail prices are used. .hoice of an average %he index numbers are known as specialized averages, a decision has to be taken which particular average should be used and the choice of the appropriate formula. %heoretically speaking the -/ is the best average in the construction of the index number. In spite of this ,/ is used (uite often in the construction of the index number because it is easy to compute compare to -/. .hoice of appropriate formula /any formulae are available for the construction of Index number& regarding the selection of the formula the 0isher+s formula is most appropriate one because it used both base year and current year+s price and (uantities. 'election of weights

# ,ll the items considered for the construction of an Index number are not of e(ual importance. It is necessary to assign weights to different items based on their relative importance. Limitations of Index Numbers %he index number is based on the sample, it is not possible to take account each and every item in the construction. $ifferent formulae are available for the construction of index number, each method yields different result, so selection of an appropriate formulae is difficult task. Index numbers can be manipulated in such a way that to draw the desired results. Classification of Index numbers Index Numbers Un weighted Simple ggregate of prices Notations: p1 2)!1 p)1 (!1 !1 21 2rice 2rice Index number. Base year price. .urrent year (uantity. .urrent year )1 Base year (1 3)!1 ()1 3uantity 3uantity Index number. Base year (uantity. 4)!1 p!1 4alue Index number. .urrent year price. Simple verage of price relatives Weighted Weighted ggregate of prices Weighted vg of price relatives

p! !)) 2rice relative, 2 = p)

!"pes of Index numbers %he different types of Index numbers are (a 2rice Index number (b 3uantity Index number (c 4alue Index number 2rice Index number %he price index number reflects the general changes in the prices of various items in current period with respect to base period. $epending on the type of the prices either whole sale price index or retail price index can be used. In computing price index numbers (uantities are used as weights. 3uantity Index number , (uantity index measures the relative changes in the (uantity levels of group of items produced or consumed, such as agricultural and Industrial production, imports and exports between current and base periods. %hese are important indicators of level of output in the economy. In computing (uantity index numbers prices are used as weights. %he various (uantity index numbers can be obtained by interchanging p and ( in the respective price index numbers. 4alue Index number , value index measures the relative changes in total monetary worth of an item, such as inventories, sales, foreign trade etc., between current and base periods. Un weighted Index numbers

$ In this case all the items under considerations are treated with e(ual importance (no explicit weights are assigned to the items & the different index numbers under this method are, (a 'imple aggregate of prices (b 'imple average or price relatives Simple aggregate of Prices method

2)! =

p! !)) p)
2 when ,/ is used
n
log 2 when -/ n

Simple Average of Price relatives method (a is used Weighted Index numbers 5hile constructing un weighted index number e(ual importance is given to all the items under consideration, but in reality all the items are not of e(ual importance. It is necessary to assign weights based on their relative importance. In case of price index numbers the (uantities bought or sold in the base year or current year are used as weights. %here are two types of 5eighted Index numbers, they are (a 5eighted aggregate of prices (b 5eighted aggregate of price relatives. Weighted aggregate of prices In this case weights are assigned to different commodities. $ifferent authors used different weights& as a result of this different formulae are available. 'ome of them are listed in the following table. Index number 6aspeyre+s Price Index number
6 2)! =

2)! =

(b

2)! = ,ntilog

Quantity Index number

Remarks

p!() !)) p ) ()

36 )! =

(weights1 Base year (uantities

2 2)! =

(!p ) !)) () p )

(weights1 Base year prices

2aasche+s

p!(! !)) p ) (!

32 )! =

(!p! !)) ( ) p!

(weights1 .urrent year (uantities /arshall *dgeworh+s

/* 2)! =

(weights1 .urrent year prices

p!() + p!(! !)) p)() + p)(!

3 /* )! =

(!p ) + (!p! !)) ( ) p ) + ( ) p!

(weights1 ,verage of base and current year (uantities

$B 2)! =

(weights1 ,verage of base and current year prices

$orbish Bowley+s

! p!() ! (!p ) p!(! (!p! $B + + !))3 )! = !)) ,/ of " p ) () p ) (! " ( ) p ) ( ) p! 6aspyre+s

OR
"

OR
"

$B 2)! =

6 2)!

2 + 2)!

!))

3$B )! =

36 )!

+ 32 )!

!))

and 2aasche+s

&
0 2)! =

0isher+s

p!() p!(! !)) p ) () p ) (!

OR
0 2)!

30 )! =

(!p ) (!p! !)) ( ) p ) () p!

OR
30 )! =
2 36 )! 3 )!

6 2)!

2 2)!

-/ of 6aspyre+s and 2aasche+s

he !uantity index number can be obtained from price index number by interchanging p and !

Weighted average of price relatives %his method is similar to the simple average of price relatives method with the fundamental difference that explicit weights are assigned to each commodity included in the index. %he various weighted index numbers are (a (b

2w if ,/ used w w log 2 2 )! = ,ntilog if -/ is used w

2 )! =

5here 2 is price relative and w are corresponding weights. Note% If base year values (p)() are taken as weights then the weighted average of relatives method gives Laspyres price index number when ,/ is used. If weights w 7 p)(! (base year prices multiplied by current year (uantities then the resultant would be the formula obtained in Paasches price index. !ests for index numbers ,s there are several formulae available for the construction of index numbers, the problem is to select the most appropriate one. 2rof Irving 0isher suggested two tests for selecting an appropriate formula. %hey are (a %ime 8eversal %est (%8% (b 0actor 8eversal %est (08% %ime 8eversal %est %he formula calculating the index should be such that it will give same ratio between one point of comparison and another, no manner which of the two is taken as base. In other words, the index number prepared forward should be reciprocal of the index number prepared backwards . %his means that if time subscripts of an index number formula are interchanged then the resulting will be the reciprocal of original index i.e. 2)! 2!) = !. 0actor 8eversal %est %he formula for constructing index number should permit not only the interchange of the two items, it also permit interchange of weights. i.e. 2)! 3 )! = relatives should be e(ual to the value ratio. 9ote1 %o carry out the test mere ratios should be considered (Index numbers should not be multiplied with !))

p! (! p ) ()

i.e. the product of price and (uantity

( 'ummary of tests of Index numbers1 Name of the Index Number 6aspyre+s 2aasche+s $orbish : Bowley+s /arshall : *dgeworh+s 0isher+s ime Reversal est $oes not satisfies $oes not satisfies $oes not satisfies 'atisfies 'atisfies "actor Reversal est $oes not satisfies $oes not satisfies $oes not satisfies $oes not satisfies 'atisfies

Note% 0isher+s index number is known as an ideal index number because, (a It is based on -/ (-/ is considered as best average in the construction of Index number . (b (c (d It is based on both current year and base year+s price and (uantities. It satisfies both time and factor reversal tests. It is free from bias.

Consumer 'rice Index number

%he consumer price index number is also known as ost of living index numbers or Retail price !ndex numbers. It is constructed for a particular class of consumers of a have to pay to get a basket of goods and services at a particular point of time in comparison to what they paid for the same in the base year. %he need for constructing consumer price index number arises because the general indices do not highlight the effects of rise or fall in the prices of various commodities consumed by different class of consumers on their cost of living. $ifferent class of consumers consumes different commodities and even the same type of commodities at different proportion. %o study the effect of rise or fall in prices of different types of commodities, the .ost of 6iving Index (.6I is constructed separately for different class of people. Uses% !. ;sed in calculating purchasing power of money ". ;sed comparing the cost of living indices for different class of people. Steps involved in construction of Cost of Living Index numbers $efining scope and coverage1 5hile constructing the consumer price index number it is necessary to define for which class of customers the index number is meant for. %he class of consumers may be government employees, bank employees, person from /9.+s etc., while constructing the index number the consumers with the same pattern of consumption is considered. .onducting family budget en(uiry and assigning weights1 ,fter defining the scope and coverage the next step to conduct family budget en(uiry, here an en(uiry on the allocation of budget on different items of consumption is carefully recorded. ,ll the items under consumption may not be e(ually important. %he weights are assigned to the items based on their relative importance. %he different group of items considered in case are (i 0ood, (ii .lothing, (iii 0uel and lighting , (iv *ducation and (v /iscellaneous expenses. Obtaining price (uotations1 ,fter selecting the items the next step is to obtain the price (uotations for the selected commodities. It is known that the price of the commodity is varies from place to place. %he prices should be collected from different places and then they have to be averaged and average price is considered for the construction of index number. -enerally price (uotations are collected from the places where the commodities are bought and sold in large (uantities. .onsumer price index number can be computed by using, (a ,ggregative expenditure method. (b 0amily budget method.

* ,ggregative expenditure method1 In this case the base year !uantities are taken as weights. It is given by 2)! = 0amily budget method1 It is the #eighted arithmetic mean of price relatives. %he weights assigned are the expenditure in the normal period, if is given by, 2)! =

p!() !)) p ) ()

2w . w
))))))))))