Index Numbers

Question 1

Define index numbers

Answer 1

An index number is a device to measure changes in an economic variable (or group of variables) over a period of time

Question 2

The first study using index numbers

Answer 2

Early 18th century.
The first recorded index number appeared in the work of G.R Carli, an Italian who used a modifies form of the simple average of price relatives in 1764

Question 3

Where are William Fleetwood’s results presented?

Answer 3

‘Chronicon Preciosum’

Question 4

Definition of index number by Spiegel

Answer 4

An index number is a statistical measure designed to show changes in a variable or group of variables with reference to time, geographical location and other characteristics such as income, profession, etc.

Question 5

Definition of index number by Croxton and Cowden

Answer 5

Index numbers are devices for measuring differences in the magnitude of a group of related variables

Question 6

Features of Index numbers

Answer 6

1. statistical devices
2. specialized averages which can be expressed in percentages
3. measure net change in one or more related variables over a period of time or two different time periods or two locations
4. Computed for single variable- univariate
5. Computed for group of variables- composite
6. The year for which index is computed is called the current year. denoted by suffix “I”
7. The year with which changes are measured is called base year. it is denoted by suffix “0”
8. The index of base year is assumed to be 100 and the index of current year is measured accordingly
9. They are also called “barometers of economic activity” as they measure the trends and changes

Question 7

Types of index numbers

Answer 7

1. Price
2. Quantity
3. Value
4. Special purpose

Question 8

Price index number

Answer 8

It measures the general changes in the price of goods.
It compares the level of prices between two different time periods

Question 9

Quantity index number

Answer 9

Also called volume index number.
It measures changes in the level of output of physical volume of production in the economy.
For eg: changes in agricultural production, industrial production,etc

Question 10

Value index number

Answer 10

The value of a commodity is the product of its price and quantity.
It measure the changes in the value in terms of rupee.
It is a more informative index as it combines both,change in price and quantity

Question 11

Special purpose index numbers

Answer 11

They are constructed with some specific purpose.
For eg: import-export, labour productivity, share price

Question 12

Significance of index numbers

Answer 12

1. Framing suitable policies
2. Forecasting about future economic activity
3. Measurement of inflation
4. Studies trends and tendencies
5. Useful to present financial data in real terms

Question 13

Framing suitable policies

Answer 13

Index numbers provide guidelines to policy makers in framing suitable policies such as agricultural policy, industrial policy, fixation of wages and dearness allowance in accordance with the cost of living, etc.

Question 14

Forecasting about future economic activity

Answer 14

useful for making predictions for the future based on the analysis of the past and present trends in the economic activity.
For eg: based on the data pertaining imports and exports, we can make future predictions.
Forecasting guides in proper decision making

Question 15

Measurement of inflation

Answer 15

Index numbers are used to measure changes in price level from time to time.
They enable the government to undertake anti-inflationary measures.
There is a legal provision to pay the DA to employees of the organised sector on the basis of the changes in the Dearness index

Question 16

Studies trends and tendencies

Answer 16

Widely used to measure changes in economic variables such as production, prices, etc over a period of time.
For eg: by examining the index of industrial production for the last five years, we can draw important conclusions about the trend of industrial production, whether it shows an upward or downward tendency

Question 17

Useful to present financial data in real terms

Answer 17

Deflating means to make adjustments in the original data. Index numbers are used to adjust price changes, wage changes,etc.
Thus, deflating helps in presenting financial data in real terms(at constant prices)

Question 18

Define deflating

Answer 18

means to make adjustments in the original data

Question 19

Construction of index numbers

Answer 19

1. PURPOSE
2. SELECTION OF BASE YEAR
3. SELECTION OF ITEMS
4. SELECTION OF PRICE QUOATATIONS
5. CHOICE OF A SUITABLE AVERAGE
6. ASSIGNING PROPER WEIGHTS
7. SELECTION OF APPROPRIATE FORMULA

Question 20

PURPOSE

Answer 20

The purpose for constructing the index number, its scope
as well as which variable is intended to be measured should be clearly decided to achieve fruitful results

Question 21

Selection of base year

Answer 21

Base year is also called the reference year. It is the year
against which comparisons are made. The base year should be normal i.e. it should be free from natural calamities. It should not be too distant in the past.

Question 22

Selection of items

Answer 22

It is necessary to select a sample of the number of items to be included in the construction of a particular index
number. For example, in the construction of price index numbers it is impossible to include each and every commodity. The commodities to be selected should represent the tastes, habits and customs of the people.
Besides this, only standardized or graded items should be included to give better results.

Question 23

Selection of price quotation

Answer 23

Prices of the selected commodities may vary from place to place and shop to shop in the same market. Therefore, it is desirable that price quotations should be obtained from an unbiased price reporting agency. To achieve accuracy, proper selection of representative places and persons is required.

Question 24

Choice of a suitable average

Answer 24

Construction of index numbers requires choice of a suitable average. Generally, Arithmetic mean is used in the construction of index numbers because it is simple to compute compared to other averages

Question 25

Assigning proper weights

Answer 25

Weight refers to the relative importance of the different items in the construction of an index number. Weights are of two types i.e. quantity weights (q) and value weights
(p x q). Since all items are not of equal importance, by assigning specific weights, better results can be achieved

Question 26

Selection of an appropriate formula

Answer 26

Various formulae are devised for the construction of index numbers. Choice of a suitable formula depends upon the purpose of index number and availability of data

Question 27

Methods of constructing index numbers

Answer 27

1. simple
2. weighted

Question 28

Simple index number

Answer 28

in this method, every commodity is given equal importance.
easiest method
applied to determine price, quantity, value

Question 29

Weighted index numbers

Answer 29

in this, suitable weights are assigned to commodities.
it gives relative importance to the commodity in the group.
in most cases, quantites are used as weights
methods- laaspeyre’s, paasche’s price index

Question 30

laaspeyre’s price index

Answer 30

base year quantities are considered weights
P01 = Σp1q0/Σp0q × 100

Question 31

paasche’s price index

Answer 31

quantities of current year as weights
P01 = Σp1q1/Σp0q1× 100

Question 32

Limitations of Index numbers

Answer 32

1. Based on samples
2. Bias in the data
3. Arbitary weights
4. Defects in formulae
5. Misuse of index numbers
6. Changes in the economy
7. Qualitative changes
8. Limited scope

Question 33

Based on samples

Answer 33

Index numbers are based on samples.
We cannot include all the items in the construction.
Hence they are not free from sampling errors

Question 34

Bias in the data

Answer 34

Index numbers are constructed on the basis of various types of data which may be incomplete. they may be bias in the data. this is bound to affect the results

Question 35

Arbitrary weights

Answer 35

The weights assigned to different commodities may be arbitrary

Question 36

Defects in formulae

Answer 36

There is no perfect formula for construction of an index number.
It is only an average and so it has all the limitations of an average

Question 37

Misuse of index numbers

Answer 37

Index numbers can be misused. They compare a situation in the current year with a situation in the base year. Hence a person may choose a base year suitable for their purpose.
For eg: a businessman may choose a base year in which his profict was low and show that his profit is rising in the current years