CHAPTER 3

The Index Numbers:

 3.1 Definition and Concepts:

Index Number:
 An index number is a specialized average designed to measure the changes in a
variable with respect to time , geographical location or characteristics such as
income, profession etc.
3.2 Characteristics of Index Numbers
An Index Number is:
 specialized averages which are used for comparison of variables which have
different units.
 It measures the net change in a group of related variables over a period of
time or between places.
 Index numbers measures changes which are not directly measurable.
 The cost of living, the price level or the business activity in a country are not
directly measurable but it is possible to study relative changes in these
activities by measuring the changes in the values of variables/factors which
affect these activities.
 It measures the effect of changes over a period of time.
3.3 Uses of index numbers
• Helpful in formulation of policies
• Helpful in measuring inflation and deflation
• Helpful in knowing the changes in standard of living
• Useful to government in studying changes in trend.
• They measure the level of business and economic activities and are therefore
helpful in guiding the economic status of the country.
• Very helpful in finding out whether a business firm’s sales are increasing in
physical volume as opposed to rupee value.
• Used to adjust wages or salaries on account of rising prices or inflation.
• Index numbers can be used for providing incentive to efficient workers.
3.4 Problems in Index Number Construction
Points to be considered before starting the actual construction of
any type of index numbers.

 Purpose of Index numbers under construction

 Choice of an appropriate average
 Assignment of weights (importance)
 Selection of base period
 Selection of items
 Selection of source of data
 Collection of data
 3.5 Types of index numbers

• There are various types of index numbers, but in brief, we shall take three kinds
and they are
1. Price Index
2. Quantity Index and
3. Value Index

1. Price Index:
 For measuring the value of money, in general, price index is used.
 It is an index number which compares the prices for a group of commodities at a
certain time as at a place with prices of a base period.
 It is the ratio of the price of a certain number of commodities at the present year
as against base year.
Cont.…

2. Quantity Index:
 Quantity index number is the changes in the volume of goods produced or
consumed. They are useful and helpful to study the output in an economy.

3. Value Index:
 Value index numbers compare the total value of a certain period with total value
in the base period.
 These pertain to compare changes in the monetary value of imports, exports,
production or consumption of commodities.
 3.6 Method of construction of index numbers:
 Index numbers may be constructed by various methods as
shown below:
 3.6.1 Simple Aggregate Index Number:
 This is the simplest method of construction of index numbers
which is given as:
 Example 1: Calculate index numbers from the following data by
simple aggregate method taking prices of 2000 as base.


Commodity Price in the Year Price in the Year
2000 2004
A 80 95
B 50 60
C 90 100
D 30 45
 3.6.2 Simple Average Price Relative index:
In this method, first calculate the price relative for the various
commodities and then average of these relative is obtained by
using arithmetic mean and geometric mean.
 If Arithmetic mean is used:
If Geometric Mean is Used:
 Example 2:
 From the following data, construct an index for 1998 taking
1997 as base by the average of price relative using
 (a) arithmetic mean and (b) Geometric mean
 3.6.3 Weighted aggregate index numbers:
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

1. Laspeyre’ s method
2. Paasche’ s method
3. Fisher’ s ideal Method
4. Bowley’ s Method
5. Marshall- Edgeworth method
6. Kelly’ s Method
 1. Laspeyre’s method

2. Paasche’ s method:
 3. Fisher’ s ideal Method:
 Fisher’ s Price index number is the geometric mean of the
Laspeyres and Paasche indices Symbolically:

It is known as ideal index number because

(a) It is based on the geometric mean
(b) It is based on the current year as well as the base year
(c) It conform certain tests of consistency
(d) It is free from bias.
 4. Bowley’ s Method:
Bowley’ s price index number is the arithmetic mean of Laspeyre’ s and
Paasche’ s method. Symbolically:

5. Marshall- Edgeworth method:

6. Kelly’ s Method:
Example 3:
Construct price index number from the following data by
applying
1. Laspeyere’ s Method
2. Paasche’ s Method
3. Fisher’ s ideal Method
 Example 4:

Calculate the index number from the following data by applying

(a) Bowley’ s price index (b) Marshall- Edgeworth price index

 Example 5:
 Calculate a suitable price index from the following data
 3.6.4 Weighted Average of Price Relative index.
 When the specific weights are given for each commodity,
the weighted index number is calculated by the formula.
Cont..
Cont..