INDEX NUMBERS

Contents

Base shifting
Introduction
Splicing
Definition
Deflating
Characteristics
CPI : Uses, Problems,
Uses
cons. methods
Problems
Classification
Methods
Value index numbers
Chain index numbers.

INTRODUCTION
An index number measures the
relative change in price, quantity,
value, or some other item of interest
from one time period to another.
A simple index number measures the
relative change in one or more
than one variable.

WHAT IS AN INDEX
NUMBER

DEFINITION
Index
numbers
are
quantitative
measures of growth of prices, production,
inventory and other quantities of
economic interest.

-Ronold

CHARACTERISTICS OF INDEX
NUMBERS
Index numbers are specialised
averages.
Index numbers measure the change
in the level of a phenomenon.
Index numbers measure the effect of
changes over a period of time.

USES OF INDEX
NUMBERS
o They reveal trends and tendencies.
o To framing suitable policies.
o Index numbers are very useful in
deflating value of concerned
variable.

PROBLEMS RELATED TO INDEX

NUMBERS
Purpose of index
Availability and comparability of
data
Choice of the base period.
Choice of an average.
Choice of index.
Selection of commodities.
Data collection.

CLASSIFICATION OF INDEX
NUMBERS

METHODS OF CONSTRUCTING
INDEX NUMBERS

SIMPLE AGGREGATIVE
METHOD
It consists in expressing the aggregate price
of all commodities in the current year as a
percentage of the aggregate price in the
base year.

P01

100

pP1 01= Index number of the current year.

= Total of the current years price of all
p0 commodities.
= Total of the base years price of all
commodities.

EXAMPLE:From the data given below construct the index

number for the year 2008 on the base year
2007 in Punjab state.
COMMODITIES

UNITS

PRICE (Rs)
2007

Sugar

Quintal

2200

3200

Milk

Quintal

18

20

Oil

Litre

68

71

Wheat

Quintal

900

1000

Clothing

Meter

50

60

PRICE (Rs)
2008

Solution:COMMODITIES

UNITS

PRICE (Rs)
2007

Sugar

Quintal

2200

3200

Milk

Quintal

18

20

Oil

Litre

68

71

Wheat

Quintal

900

1000

Clothing

Meter

50

60

3236

PRICE (Rs)
2008

4351

Index Number for 2008-

P01

1
0

100

4351
100 134.45
3236

It means the prices in 2008 were 34.45% higher than the previous year.

SIMPLE AVERAGE OF RELATIVES

METHOD.

The current year price is expressed as a price

relative of the base year price. These price
relatives are then averaged to get the index
number. The average used could be arithmetic
mean, geometric mean or even median.
p1

p 100

P01 0
N
Where N is Numbers Of items.
When geometric mean is used-

p1

log p 100
0

log P01
N

Example
From the data given below
construct the index number for
the year 2008 taking 2007 as
base
year. Price (2007)
Commodities
Price (2008)
P

10

12

10

12

12

Solution-

Index number using arithmetic meanCommodities

Price (2007)

p0

Price (2008)

p1

Price
p1
Relative
100
p0

10

166.7

12

16.67

150.0

10

12

120.0

12

150.0
p1

=603.37
100
p
0

p1

p 100 603.37
0

P01
120.63
N
5

Weighted index numbers

These are those index numbers in which rational weights are
assigned to various chains in an explicit fashion.
(A)Weighted aggregative index numbersThese index numbers are the simple aggregative type with the
fundamental difference that weights are assigned to the various items
included in the index.

Laspeyres method.
Paasche method.
Fishers ideal method.
Dorbish and bowleys method
Marshall-Edgeworth method.
Kellys method.

Laspeyres MethodThis method was devised by Laspeyres in 1871. In this

method the weights are determined by quantities in the
base.

p01

pq

p q

1 0

100

0 0

Paasches Method.
This method was devised by a German statistician Paasche
in 1874. The weights of current year are used as base year
in constructing the Paasches Index number.

p01

pq

p q

1 1
0 1

100

Dorbish & Bowleys Method.

This method is a combination of Laspeyres and Paasches methods. If
we find out the arithmetic average of Laspeyres and Paasches index
we get the index suggested by Dorbish & Bowley.

p01

pq pq
p q p q

1 0

1 1

0 0

0 1

100

Fishers Ideal Index.

Fishers deal index number is the geometric mean of the Laspeyres and
Paasches index numbers.

P01

p q p q 100
pq pq
1

Marshall-Edgeworth Method.
In this index the numerator consists of an aggregate of the
current years price multiplied by the weights of both the
base year as well as the current year.

p01

p q p q

p q p q
1 0

1 1

0 0

0 1

100

Kellys Method.
Kelly thinks that a ratio of aggregates with selected weights (not
necessarily of base year or current year) gives the base index number.

p01

pq

100
p q
1

q refers to the quantities of the year which is selected as the base.

It may be any year, either base year or current year.

ExampleGiven below are the price quantity

data,with price quoted in Rs. per kg
and production in qtls.
Find- (1) Laspeyers Index (2) Paasches
Index (3)Fisher Ideal Index.
2002

2007

ITEMS

PRICE

PRODUCTION

PRICE

PRODUCTION

Wheat

15

500

20

600

Rice

18

590

23

640

Maize

22

450

24

500

SolutionITEMS

PRICE

p0

PRODUC
TION

PRICE

q0

p1

PRODU
CTION

q1

p1q0 p0 q0 p q p0 q1
1 1

Wheat

15

500

20

600

10000

Rice

18

590

23

640

13570 10620 14720 11520

Maize

22

450

24

500

10800

TOTAL

7500

9900

12000

9000

12000 11000

34370 28020 38720 31520

Solution1.Laspeyres index:
p1q0
34370

p01
100
100 122.66
28020
p0 q0
2. Paasches Index :

p01

pq

p q

38720
100
100 122.84
31520
1

1 1
0

3. Fisher Ideal Index

P01

p q p q 100
pq pq
1

34370 38720

100 122.69
28020 31520

Weighted average of price relative

In weighted Average of relative, the

price relatives for the current year
are calculated on the basis of the
base year price. These price
relatives are multiplied by the
respective weight of items. These
products are added up and divided
by the sum of weights.
PV

Where- P P1 100
P

Weighted
arithmetic
mean
of
01
V
P

0
price relativeP=Price relative
V=Value weights=

p0 q0

Value index numbers

Value is the product of price and
quantity. A simple ratio is equal to the
value of the current year divided by
the value of base year. If the ratio is
multiplied by 100 we get the value
index number. p q

V
pq
1

100

Value Index - Example

The prices and quantities sold at a Clothing Emporium for
various items of apparel for May 2000 and May 2005 are:

What is the index of value for May 2005 using May 2000 as the base period?
26

Value Index - Example

27

Chain index numbers

When
this
method
is
used
the
comparisons are not made with a fixed
base, rather the base changes from year
to year. For example, for 2007,2006 will
be the base; for 2006, 2005 will be the
same and so on.
Chain index for current year

Average link relative of current year Chain index of previous year

100

Example From the data given below

construct an index number by
chain base method.
Price ofYEAR
a commodity PRICE
from 2006
to 2008.
2006
50
2007

60

2008

65

solutionYEAR

PRICE

LINK
RELATIVE

CHAIN INDEX
(BASE 2006)

2006

50

100

100

2007

60

60
100 120
50

120 100
120
100

2008

65

65
100 108
60

108 120
129.60
100

Base shifting
When previous year become too old and useless
for the purpose of comparisons
When comparison is to be made with another
series of index number having different base
Method

Base shifting : Example

Shift the base year for 1999 to 2005

Base shifting

Deflation
Used to calculate real value of monetary
variable so as to remove the impact of
inflation of deflation based on index
numbers.

Index of Real value In period t

= value in ith year/ value in base year * 100

Deflation

Splicing
Problem of combining two or more
overlapping series of index numbers
into one continuous series

Example

Example

Tests of consistency
Time reversal
test
P01 x P10 = 1

Tests of consistency
Time reversal
test
P01 x P10 = 1

Fisher Ideal Index, Marshal-Edgeworth Index,

Simple Average of Price relative Index
Weighted Geometric mean of Price relative Index
satisfy this test

Tests of consistency
Time reversal
test
P01 x P10 = 1
Factor
reversal test

Fisher Ideal Index, Marshal-Edgeworth Index,

Simple Average of Price relative Index
Weighted Geometric mean of Price relative Index
satisfy this test

Tests of consistency
Time reversal
test
P01 x P10 = 1

Fisher Ideal Index, Marshal-Edgeworth Index,

Simple Average of Price relative Index
Weighted Geometric mean of Price relative Index
satisfy this test

Only Fishers index satisfy FRT test

Factor
reversal test

Tests of consistency
Time reversal test
P01 x P10 = 1
Factor reversal
test

Circular reversal
test
P01 x P12 x P20 =
1

Fisher Ideal Index, Marshal-Edgeworth Index,

Simple Average of Price relative Index
Weighted Geometric mean of Price relative Index
satisfy this test

Only Fishers index satisfy FRT test

Tests of consistency
Time reversal test
P01 x P10 = 1
Factor reversal
test

Circular reversal
test
P01 x P12 x P20 =
1

Fisher Ideal Index, Marshal-Edgeworth Index,

Simple Average of Price relative Index
Weighted Geometric mean of Price relative Index
satisfy this test

Only Fishers index satisfy FRT test

Simple Geometric mean of Price relative Index

Weighted aggregative fixed weights index
satisfy this test

Consumer Price Index

Known as cost of living index
Represent average change over time
in prices paid by the consumer for a
specific basket of goods
Basis of policy formulation

CPI Uses
It allows consumers to determine the
effect of price increases on their
purchasing power.
It is a yardstick for revising wages,
pensions, alimony payments, etc.
It is an economic indicator of the rate of
inflation in India.
It computes real income: real income =
money income/CPI X (100)
46

CPI Uses - Formulas

47

Construction of Price Index

Decision of class for people for whom the
index is meant
General public
Industrial
Agricultural

Conducting family budget inquiry for

classification of items to be included
Obtaining price quotations from the
localities in which the class of people
concerned reside

Methods of Construction of
Index Number
1. Aggregate Expenditure
Method/aggregative methods
Commonly Laspreys method is used under this

2. Family Budget Method/Weighted

average of price relative
Commonly Value index has been used under

Precautions using CPI

Objective assessment of price
change
Does inform about change in living
standards
Does not tell us about change in
consumption pattern
Based on sampled families not whole
universe

Method to construct industrial

Production Index

 Questions and queries

Thanks