INDEX NUMBERS

DEFINITION
Index numbers are statistical devices designed to measure the relative changes in the level of a
certain phenomenon in two or more situations. According to Wheldon an index number is a
statistical device for indicating the relative movements of the data where measurement of
actual movements is difficult or incapable of being made. The phenomenon under
consideration may be any field of quantitative measurements. It may refer to a single variable
or a group of distinct but related variables. In Business and Economics, the phenomenon
under consideration may be:
 the prices of a particular commodity like steel, gold, leather, etc. or a group of
commodities like consumer goods, cereals, milk and milk products, cosmetics, etc.
 volume of trade, factory production, industrial or agricultural production, imports or
exports, stocks and shares, sales and profits of a business house and so on.
 the national income of a country, wage structure of workers in various sectors, bank
deposits, foreign exchange reserves, cost of living of persons of a particular community,
class or profession and so on.

The various situations requiring comparison may refer to either

 the changes occurring over a time, or
 the difference(s) between two or more places, or
 the variations between similar categories of objects/subjects, such as persons, groups of
persons, organisations etc. or other characteristics such as income, profession, etc.

CHARACTERISTICS OF INDEX NUMBERS

1. Index Numbers are specialized averages.
2. Index Numbers are expressed in percentages.
3. Index Numbers measure changes not capable of direct measurement, e.g. price level, cost
of living, business or economic, activity etc.
4. Index Numbers are for comparison.

USES OF INDEX NUMBER

1. Index numbers as economic barometers
2. Index numbers help in studying trends and tendencies.
3. Index numbers help in formulating decisions and policies.

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4. Price indices measure the purchasing power of money
5. Index numbers are used for deflation.
6. They measure the relative change.
7. They are of better comparison.
8. They are good guides.
9. They are the pulse of the economy.
10. They compare the wage adjuster.
11. They compare the standard of living.
12. They are a special type of averages.
13. They provide guidelines to policy.
14. To measure the purchasing power of money.

TYPES OF INDEX NUMBERS

1. Price Index Numbers: The price index numbers measure the general changes in the
prices. They are further sub-divided into the following classes:

(i) Wholesale Price Index Numbers: The wholesale price index numbers reflect the changes
in the general price level of a country.
(ii) Retail Price Index Numbers: These indices reflect the general changes in the retail
prices of various commodities such as consumption goods, stocks and shares, bank
deposits, government bonds, etc.
(iii)Consumer Price Index: Commonly known as the Cost of living Index, CPI is a
specialized kind of retail price index and enables us to study the effect of changes in the
price of a basket of goods or commodities on the purchasing power or cost of living of a
particular class or section of the people like labour class, industrial or agricultural worker,
low income or middle income class etc.
2. Quantity Index Numbers: Quantity index numbers study the changes in the volume of
goods produced (manufactured), consumed or distributed, like: the indices of agricultural
production, industrial production, imports and exports, etc.
3. Value Index Numbers: These are intended to study the change in the total value (price
multiplied by quantity) of output such as indices of retail sales or profits or inventories.

PROBLEMS IN THE CONSTRUCTION OF INDEX NUMBERS

1. Purpose of the index numbers.
2. Selection of weights to be used.

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3. Type of average to be used.
4. Choice of Index:
5. Selection of base period.
6. Selection of commodities.
7. Selection of source of data.
8. Collection of data.

NOTATIONS USED FOR INDEX NUMBERS

Since index numbers are computed for prices, quantities, and values, these are denoted by the
lower case letters:
p, q and v represent respectively the price, the quantity, and the value of an
individual commodity

Subscripts 0, 1, 2,… i, ... are attached to these lower case letters to distinguish price, quantity,
or value in any one period from those in the other. Thus,

P0 = denotes the price of a commodity in the base period,

P1 = denotes the price a commodity in period 1, or the current period, and
Pi = denotes the price a commodity in the ith period, where i = 1,2,3, … … ..

Similar meanings are assigned to q0, q1, ... qi, ... and v0, v1, … vi, …

Capital letters P, Q and V are used to represent the price, quantity, and value index numbers,
respectively. Subscripts attached to P, Q, and V indicates the years compared. Thus,
P01 = means the price index for period 1 relative to period 0,
P02 = means the price index for period 2 relative to period 0,
P12 = means the price index for period 2 relative to period 1, and so on

Similar meanings are assigned to quantity Q and value V indices. It may be noted that all
indices are expressed in percent with 100 as the index for the base period, the period with
which comparison is to be made.

SIMPLE INDEX NUMBERS

A simple price index number is based on the price or quantity of a single commodity. To
construct a simple index, we first have to decide on the base period and then find ratio of the

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value at any subsequent period to the value in that base period - the price/quantity
relative.This ratio is then finally converted to a percentage.
𝑉𝑎𝑙𝑢𝑒 𝑖𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 𝑖
𝐼𝑛𝑑𝑒𝑥 𝑓𝑜𝑟 𝐴𝑛𝑦 𝑃𝑒𝑟𝑖𝑜𝑑 𝑖 = ∗ 100
𝑉𝑎𝑙𝑢𝑒 𝑖𝑛 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟

Simple Price Index for period i = 1,2,3 ... will be

𝑃𝑖
𝑃01 = ∗ 100
𝑃0

Similarly, Simple Quantity Index for period i = 1,2,3 ... will be

𝑞𝑖
𝑄01 = ∗ 100
𝑞0

Example 1
Given are the following price-quantity data of fish, with price quoted in Kshs per kg and
production in qtls.

Year 1980 1981 1982 1983 1984 1985

Price 15 17 16 18 22 20
Production 500 550 480 610 650 600

Construct:
(a) the price index for each year taking price of 1980 as base,
(b) the quantity index for each year taking quantity of 1980 as base.

Solution:
Simple Price and Quantity Indices of Fish (Base Year = 1980
Year Price(𝑝𝑖 ) Quantity (𝑞𝑖 ) Price Index Quantity Index
𝑝𝑖 𝑞𝑖
𝑃0𝑖 = ∗ 100 𝑄0𝑖 = ∗ 100
𝑝0 𝑞0
1980 15 500 100.00 100.00
1981 17 550 113.33 110.00
1982 16 480 106.67 96.00
1983 18 610 120.00 122.00
1984 22 650 146.67 130.00
1985 20 600 133.00 120.00

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COMPOSITE INDEX NUMBERS
Aggregative (or composite) index numbers are indices constructed for a group of
commodities or variables are known as aggregative (or composite) index numbers. Depending
upon the method used for constructing an index, composite indices may be:
1. Simple Aggregative Price/ Quantity Index
2. Index of Average of Price/Quantity Relatives
3. Weighted Aggregative Price/ Quantity Index
4. Index of Weighted Average of Price/Quantity Relatives

SIMPLE AGGREGATIVE PRICE/ QUANTITY INDEX

Irrespective of the units in which prices/quantities are quoted, this index for given
prices/quantities, of a group of commodities is constructed in the following three steps:
(i) Find the aggregate of prices/quantities of all commodities for each period (or place).
(ii) Selecting one period as the base, divide the aggregate prices/quantities corresponding to
each period (or place) by the aggregate of prices/ quantities in the base period.
(iii)Express the result in percent by multiplying by 100.

The computation procedure contained in the above steps can be expressed as:
∑ 𝑝𝑖
𝑃0𝑖 = ∗ 100 𝑎𝑛𝑑
∑ 𝑝0

∑ 𝑞𝑖
𝑄0𝑖 = ∗ 100
∑ 𝑞0
Example 2
Given are the following price-quantity data, with price quoted in Kshs per kg and production
in qtls.

1980 1985
Item Price Production Price Production
Fish 15 500 20 600
Mutton 18 590 23 640
Chicken 22 450 24 500

Find
(a) Simple Aggregative Price Index with 1980 as the base.
(b) Simple Aggregative Quantity Index with 1980 as the base.

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Calculations for Simple Aggregative Price and Quantity Indices (Base Year = 1980)
Prices Quantities
Item 1980 (𝑝0 ) 1985 (𝑝𝑖 ) 1980 (𝑞0 ) 1985 (𝑞𝑖 )
Fish 15 20 500 600
Mutton 18 23 590 640
Chicken 22 24 450 500
Sum 55 67 1540 1740

(a) Simple Aggregative Price Index with 1980 as the base.

∑ 𝑝𝑖 67
𝑃0𝑖 = ∗ 100 = ∗ 100 = 121.82
∑ 𝑝0 55

(b) Simple Aggregative Quantity Index with 1980 as the base

∑ 𝑞𝑖 1740
𝑄0𝑖 = ∗ 100 = ∗ 100 = 112.98
∑ 𝑞0 1540

INDEX OF AVERAGE OF PRICE/QUANTITY RELATIVES

Given the prices/quantities of a number of commodities that enter into the construction of this
index, it is computed in the following two steps:
(i) After selecting the base year, find the price relative/quantity relative of each commodity
for each year with respect to the base year price/quantity. As defined earlier, the price
relative/quantity relative of a commodity for a given period is the ratio of the
price/quantity of that commodity in the given period to its price/quantity in the base
period.
(ii) Multiply the result for each commodity by 100, to get simple price/quantity indices for
each commodity.
(iii) Take the average of the simple price/quantity indices by using arithmetic mean,
geometric mean or median.

Thus it is computed as:

𝑝𝑖
𝑃0𝑖 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑓 ( ∗ 100) 𝑎𝑛𝑑
𝑝𝑜

𝑞𝑖
𝑄0𝑖 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑓 ( ∗ 100)
𝑞𝑜

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Using arithmetic mean
𝑝𝑖
∑(
𝑝0 ∗ 100)
𝑃0𝑖 = 𝑎𝑛𝑑
𝑁

𝑞𝑖
∑(
𝑞0 ∗ 100)
𝑄0𝑖 =
𝑁

Using geometric mean

1 𝑝𝑖
𝑃0𝑖 = 𝐴𝑛𝑡𝑖 Log [ ∑ log ( ∗ 100)] 𝑎𝑛𝑑
𝑁 𝑝0

1 𝑞𝑖
𝑄0𝑖 = 𝐴𝑛𝑡𝑖 Log [ ∑ log ( ∗ 100)]
𝑁 𝑞0

Example 3
From the data in Example 2 find:
(a) Index of Average of Price Relatives (base year 1980); using mean, median and geometric
mean.
(b) Index of Average of Quantity Relatives (base year 1980); using mean, median and
geometric mean.

Solution:
Index of Average of Price Relatives and Quantity Relatives (Base Year = 1980)
Item Price Relative = Log ( pi ∗ 100) Quantity Relative pi
= Log ( ∗ 100)
pi p0 pi p0
= ( ∗ 100) = ( ∗ 100)
p0 p0
Fish 133.33 2.1249 120.00 2.0792
Mutton 127.78 2.1065 108.47 2.0353
Chicken 109.09 2.0378 111.11 2.0458
Sum 370.19 6.2692 339.58 6.1603

(a) Index of Average of Price Relatives (base year 1980)

i) Using Arithmetic Mean

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 pi
∑(
p0 ∗ 100) 339.58
P0i = = = 113.19
N 3

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 ii) Using Median
N + 1 th
P0i = Size of ( ) item
2
3 + 1 th
= Size of ( ) item = Size of 2nd item = 111.11
2

iii) Using Geometric Mean

1 𝑝𝑖
𝑃0𝑖 = 𝐴𝑛𝑡𝑖 Log [ ∑ log ( ∗ 100)]
𝑁 𝑝0
1
= 𝐴𝑛𝑡𝑖 Log [ (6.2689)]
3
= 𝐴𝑛𝑡𝑖 Log[2.08963] = 122.92

b) Index of Average of Quantity Relatives (base year 1980)

i) Using Arithmetic Mean
q
∑ ( i ∗ 100) 370.19
q0
Q 0i = = = 123.39
N 3

ii) Using Median

N + 1 th
Q 0i = Size of ( ) item
2
3 + 1 th
= Size of ( ) item = Size of 2nd item = 127.78
2

iii) Using Geometric Mean

1 𝑞𝑖
𝑄0𝑖 = 𝐴𝑛𝑡𝑖 Log [ ∑ log ( ∗ 100)]
𝑁 𝑞0
1
= 𝐴𝑛𝑡𝑖 Log [ (6.1603)]
3
= 𝐴𝑛𝑡𝑖 Log[2.05343] = 113.092

WEIGHTED AGGREGATIVE PRICE/QUANTITY INDICES

Weighted aggregative indices assign proper weights to individual items. 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 most important ones are:
(i) Laspeyre’ s method
(ii) Paasche’ s method

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(iii) Fisher’ s ideal Method
(iv) Bowley’ s Method
(v) Marshall- Edgeworth method

LASPEYRE’S INDEX
Laspeyre’s Price Index, using base period quantities as weights is obtained as

𝐿𝑎
∑ 𝑝𝑖 𝑞0
𝑃0𝑖 = ∗ 100
∑ 𝑝0 𝑞0

Laspeyre’s Quantity Index, using base period prices as weights is obtained as

𝐿𝑎
∑ 𝑞𝑖 𝑝0
𝑄0𝑖 = ∗ 100
∑ 𝑞0 𝑝0
PAASCHE’S INDEX
Paasche’s Price Index, using base period quantities as weights is obtained as

𝑃𝑎
∑ 𝑝𝑖 𝑞𝑖
𝑃0𝑖 = ∗ 100
∑ 𝑝0 𝑞𝑖

Paasche’s Quantity Index, using base period prices as weights is obtained as

𝑃𝑎
∑ 𝑞𝑖 𝑝𝑖
𝑃0𝑖 = ∗ 100
∑ 𝑞0 𝑝𝑖

MARSHALL-EDGEWORTH INDEX
The Marshall-Edgeworth Index uses the average of the base period and given period
quantities/prices as the weights, and is expressed as
∑(𝑞0 𝑝𝑖 + 𝑞𝑖 𝑝𝑖 )
= P0iME = ∗ 100 𝑎𝑛𝑑
∑(𝑞0 𝑝0 + 𝑞𝑖 𝑝0 )

∑(𝑝0 𝑞𝑖 + 𝑝𝑖 𝑞𝑖 )
= P0iME = ∗ 100
∑(𝑝0 𝑞0 + 𝑝𝑖 𝑞0 )

DORBISH AND BOWLEY INDEX

The Dorbish and Bowley Index is defined as the arithmetic mean of the Laspeyre’s and
Paasche’s indices.
𝐿𝑎 𝑃𝑎
𝐷𝐵
𝑃0𝑖 + 𝑃0𝑖
𝑃0𝑖 =
2
𝐿𝑎 𝑃𝑎
𝐷𝐵
𝑄0𝑖 + 𝑄0𝑖
𝑃0𝑖 =
2

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FISHER’S IDEAL INDEX
The Fisher’s Ideal Index is defined as the geometric mean of the Laspeyre’s and Paasche’s
indices.

𝐹 𝐿𝑎 𝑃𝑎
𝑃0𝑖 = √𝑃0𝑖 . 𝑃𝑂𝑖 𝑎𝑛𝑑

𝐹 𝐿𝑎 𝑃𝑎
𝑄0𝑖 = √𝑄0𝑖 . 𝑄𝑂𝑖

Example 4
From the data in Example 6.2 find:
(a) Laspeyre’s Price Index for 1985, using 1980 as the base.
(b) Laspeyre’s Quantity Index for 1985, using 1980 as the base.
(c) Paasche’s Price Index for 1985, using 1980 as the base.
(d) Paasche’s Quantity Index for 1985, using 1980 as the base.

Solution:

Calculations for Laspeyre’s and Paasche’s Indices (Base Year = 1980)

Item 𝐩𝟎 𝐪𝟎 𝐩𝟏 𝐪𝟎 𝐩𝟎 𝐪𝟏 𝐩𝟏 𝐪𝟏
Fish 7,500 10,000 9,000 12,000
Mutton 10,620 13,570 11,520 14,720
Chiken 9,900 10,800 11,000 12,000
Sum 28,020 34,370 31,520 38,720

(a) Laspeyre’s Price Index for 1985, using 1980 as the base

𝐿𝑎
∑ 𝑝𝑖 𝑞0 34,370
𝑃0𝑖 = ∗ 100 = ∗ 100 = 122.66
∑ 𝑝0 𝑞0 28,020

(b) Laspeyre’s Quantity Index for 1985, using 1980 as the base

𝐿𝑎
∑ 𝑞𝑖 𝑝0 31,520
𝑄0𝑖 = ∗ 100 = ∗ 100 = 112.49
∑ 𝑞0 𝑝0 28,020

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(c) Paasche’s Price Index for 1985, using 1980 as the base

𝑃𝑎
∑ 𝑝𝑖 𝑞𝑖 38,720
𝑃0𝑖 = ∗ 100 = ∗ 100 = 122.84
∑ 𝑝0 𝑞𝑖 31,520

(d) Paasche’s Quantity Index for 1985, using 1980 as the base

𝑃𝑎
∑ 𝑞𝑖 𝑝𝑖 38,720
𝑃0𝑖 = ∗ 100 = ∗ 100 = 112.66
∑ 𝑞0 𝑝𝑖 34,370
Example 5
Construct price index number from the following data by applying
(a) Laspeyere’ s Method
(b) Paasche’ s Method
(c) Fisher’ s ideal Method

Commodity 2000 2001

Price Quantity Price Quantity
A 2 8 4 5
B 5 12 6 10
C 4 15 5 12
D 2 18 4 20

Solution:
Commodity 𝐩𝟎 𝐪𝟎 𝐩𝟏 𝐪𝟎 𝐩𝟎 𝐪𝟏 𝐩𝟏 𝐪𝟏
A 16 32 10 20
B 60 72 50 60
C 60 75 48 60
D 36 72 40 80
Sum 172 251 148 220

La
∑ p1 q0 251
Laspeyre′ s Price Index = P01 = ∗ 100 = ∗ 100 = 145.93
∑ p0 q 0 172

Pa
∑ 𝑝1 𝑞1 220
Pasche′ s Price Index = P01 = ∗ 100 = ∗ 100 = 148.65
∑ 𝑝0 𝑞1 148

F 𝐿𝑎 𝑃𝑎
Fisher ′ s Ideal Index = P01 = √𝑃01 . 𝑃𝑂1 = √145.93 ∗ 148.65 = √21692.4945 = 147.28

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Interpretation:
The results can be interpreted as follows: If Kshs 100 were used in the base year to buy the
given commodities, we have to use Kshs 145.90 in the current year to buy the same amount of
the commodities as per the Laspeyre’ s formula. Other values give similar meaning.

Example 6
Calculate the index number from the following data by applying
(a) Bowley’ s price index
(b) Marshall- Edgeworth price index

Commodity Base year Current year

Quantity Price Quantity Price
A 10 3 8 4
B 20 15 15 20
C 2 25 3 30

Solution:
Commodity 𝐩𝟎 𝐪𝟎 𝐩𝟏 𝐪𝟎 𝐩𝟎 𝐪𝟏 𝐩𝟏 𝐪𝟏
A 30 40 24 32
B 300 400 225 300
C 50 60 75 90
Sum 380 500 324 422

La Pa
DB
P01 + P01 1 p1 q0 p1 q1
Dorbish and Bowley Index = P01 = = [ + ] ∗ 100
2 2 p0 p0 p0 q1
1 500 422
= [ + ] ∗ 100
2 380 324
1
= [1.316 + 1.302] ∗ 100
2
1
= [1.316 + 1.302] ∗ 100
2
1
= [2.168] ∗ 100 = 130.9
2

ME
∑(𝑞0 𝑝1 + 𝑞1 𝑝1 )
Marshall − Edgeworth Index = P01 = ∗ 100
∑(𝑞0 𝑝0 + 𝑞1 𝑝0 )

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 500 + 422
=[ ] ∗ 100
380 + 324
922
=[ ] ∗ 100 = 130.966
704

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