Index Numbers Flashcards
Define index numbers
An index number is a device to measure changes in an economic variable (or group of variables) over a period of time
The first study using index numbers
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
Where are William Fleetwood’s results presented?
‘Chronicon Preciosum’
Definition of index number by Spiegel
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.
Definition of index number by Croxton and Cowden
Index numbers are devices for measuring differences in the magnitude of a group of related variables
Features of Index numbers
- statistical devices
- specialized averages which can be expressed in percentages
- measure net change in one or more related variables over a period of time or two different time periods or two locations
- Computed for single variable- univariate
- Computed for group of variables- composite
- The year for which index is computed is called the current year. denoted by suffix “I”
- The year with which changes are measured is called base year. it is denoted by suffix “0”
- The index of base year is assumed to be 100 and the index of current year is measured accordingly
- They are also called “barometers of economic activity” as they measure the trends and changes
Types of index numbers
- Price
- Quantity
- Value
- Special purpose
Price index number
It measures the general changes in the price of goods.
It compares the level of prices between two different time periods
Quantity index number
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
Value index number
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
Special purpose index numbers
They are constructed with some specific purpose.
For eg: import-export, labour productivity, share price
Significance of index numbers
- Framing suitable policies
- Forecasting about future economic activity
- Measurement of inflation
- Studies trends and tendencies
- Useful to present financial data in real terms
Framing suitable policies
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.
Forecasting about future economic activity
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
Measurement of inflation
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
Studies trends and tendencies
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
Useful to present financial data in real terms
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)
Define deflating
means to make adjustments in the original data
Construction of index numbers
- PURPOSE
- SELECTION OF BASE YEAR
- SELECTION OF ITEMS
- SELECTION OF PRICE QUOATATIONS
- CHOICE OF A SUITABLE AVERAGE
- ASSIGNING PROPER WEIGHTS
- SELECTION OF APPROPRIATE FORMULA
PURPOSE
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
Selection of base year
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.
Selection of items
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.
Selection of price quotation
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.
Choice of a suitable average
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
