INDEX NUMBER NOTES

Introduction to index number: An index number is a statistical device for measuring

changes in the magnitude of a group of related variables.
Index numbers measure a net or relative change in a variable or a group of variables. ● For
example, if the price of a certain commodity rises from ₹10 in the year 2007 to ₹15 in the year
2017, the price index number will be 150 showing that there is a 50% increase in the prices over
this period.

Purpose of Constructing Index Number

 Purpose of constructing index number of prices is to know the relative change or

percentage in the price level over time. A rising general price level over time is a
pointer towards inflation, while a falling general price level over time is a pointer
towards deflation.
 Purpose of constructing index number of quantity is to know relative change or
percentage change in the quantum or volume of output of
different goods and services. A rising index of quantity suggests a
rising level of economic activity and vice-versa.

Features of Index Number

1. Index numbers are expressed in terms of percentages. However,

percentage sign (%) is never used.
2. Index numbers are relative measurement of group of data.
3. Index numbers offer a precise measurement of the quantitative
change in the concerned variables over time.
4. Index number show changes in terms of averages.
5. They are expressed in numbers.
6. Index number facilitates the comparative study over
different time period.
Importance of Index number

1. It serves as a barometer for measuring the value of money.

2. Gives knowledge about change in standard of living.
3. It helps the business community in planning their decision.
 4. Helpful to determine the rate of premium.

What are the advantages of index numbers?

Index numbers are one of the most widely used statistical

tools. Some of the advantages or uses of index numbers are
as follows:

(1) Help in formulating ● Most of the economic and

policies business decisions and policies are
guided by the index numbers.
● Example:

● To increase DA, the government

refers to the cost-of-living index.

● To make any policy related to

the industrial or agricultural
production, the government refers
to their respective index numbers.

(2) Help in study of ● Index numbers help in the

trends study of trends in variables like,
export-import, industrial and
agricultural production, share
prices, and more.

(3) Helpful in ● Index numbers not only help in

forecasting the study of past and present
behaviour, they are also used for
forecasting economic and business
activities.

(4) Facilitates ● To make comparisons with

comparative study respect to time and place
especially where units are
different, index numbers prove to
be very useful.
 ● For example, change in
‘industrial production’ can be
compared with change in
‘agricultural production’ with the
help of index numbers.

(5) Measurement of ● Index numbers, such as cost

purchasing power of inflation index help in measuring
money to maintain the purchasing power of money at
standard of living different times between different
regions.
● Such analysis helps the
government to frame suitable
policies for maintaining or raising
the standard of living of the people.

(6) Act as economic ● Index numbers are very useful

barometer in knowing the level of economic
and business activities of a
country. So, these are rightly
known as economic barometers.

LIMITATIONS OF INDEX NUMBER

What are the major limitations of index numbers?

Following are the major limitations of index numbers:

(1) Difficulty in ● The decision of objective, selection

construction of of base period, selection of
index numbers commodities, selection of sources of
data, selection of ‘weights’, selection of
formula, and more are the several
difficulties in the construction of index
numbers.
(2) Based on ● Index numbers are generally based
sample items, so on a few sample items. So, the results
only approximate derived are approximate and not
indicators perfect.

(3) Ignores quality ● These days the quality changes occur

of commodities very fast and the index numbers ignore
this aspect.
● So, the results shown by these may
not be appropriate.

(4) Limited use ● There is no ‘master index number’ or

‘all in one index number’.
● Use of each index number is
restricted to its specific object.

(5) Useful only for ● Over a period of time, rapid changes

short-term occur in habits, tastes, preferences, and
comparison more.
● So,the index number constructed in
the present may not be comparable with
the one constructed a few years back.

PROBLEMS IN THE CONSTRUCTIONS OF INDEX NUMBER

Following are some of the problems involved in the

construction of index numbers:

(1) Purpose of ● Many different types of index numbers

index numbers are constructed with different objectives.
● Example: Price index, quantity index,
consumer price index, wholesale price
index, and more

● So, the first important issue/problem

is to define the objective for which the
index number is to be constructed.
(2) Selection of ● Base period is the period against which
base period the comparisons are made.
● Selection of a suitable base period is a
very crucial step.

● It should be of reasonable length and

normal one, i.e., it should not be affected
by any abnormalities like, natural
calamities, war, extreme business cycle
situations.

● It should neither be too close nor too

far.

(3) Selection of ● All the items cannot be included in the

commodities construction of an index number.
● Nature and number of items to be
included in an index number depends
upon the type of index to be constructed.

● For example, to construct a

‘consumer price index’ those
commodities should be considered that
are generally consumed and the number
should be neither too small nor too big.

(4) Selection of ● Depending upon the type of index

sources of data numbers, the correct source should be
selected for data.
● Like, to construct CPI, we need retail
prices and to construct the wholesale
price index, we need wholesale prices.
Accordingly, the right and reliable source
should be selected.

(5) Selection of ● The term ‘weight’ refers to the relative

weights importance of different items in the
construction of index numbers.
 ● All the items do not have the same
importance.

● So, it is necessary to adopt some

suitable measures to assign weight.

(6) Selection of ● There are various formulas for

an appropriate construction of index numbers like
formula Laspeyres’ method, Paasche’s method,
Fisher’s method, and more.
● No single formula is appropriate for all
types of index numbers.

● The choice of formula depends upon

the purpose of the available data.

Types of Index numbers:

(i) Wholesale price index (WPI)
(ii) Consumer price index (CPI) or Cost of living index
(iii) Index of industrial production (IIP)
(iv) Index of Agricultural production (IAP)
(v) Sensex
Methods of constructing index numbers:
1. Construction of Simple Index numbers
a. Simple Aggregative Method
b. Simple Average of Price Relatives Method
2. Construction of weighted Index numbers
a. weighted Average of Price Relative Method
b. Weighted Aggregative Method
Simple aggregative method:

Here, = Price index of the current year.

= Sum of the prices of the commodities in the current year

= Sum of the prices of the commodities in the base year

Current year: Current year is the year for which average change is to
be measured or index of index number is to be calculated.
Base year: Base year is the year of reference from which we want
measure extent of change in the current year. The index number of
base year is generally assumed to be 100.
Weighted average of price relative method:

Here, = Index number for the current year in relation to base year

W = Weight, R = Price relatives i.e.

(i) Consumer price index (CPI): CPI is also known as the cost of living
index, measures the average change in retail prices.

(A) Consumer price ● Consumer price index (CPI) measures

index number changes in the cost of living due to changes in
the retail prices of a basket of goods over a
period of time.
● Separate cost of living index is prepared for
different classes of people.

● It is also known as the cost of living index

numbers or retail price index number.

(B) Following are the uses of consumer price index number:

(1) Helpful in ● Consumer price index has an inverse relation

measuring the with the purchasing power of money.
purchasing power of ● Purchasing power of money = 1/Consumer
money price index

● As CPI increases, the purchasing power of

money decreases.

(2) Helpful in wage ● CPI helps in determining wages for a

negotiations particular class.
 ● It provides the basis for wage negotiations
between the workers and employers.

(3) Help government ● These index numbers provide guidelines for

in framing policies the formulation of wage policy, price policy,
taxation policy, and other general economic
policies.

(4) Market analysis ● CPI also helps a market analyst to

determine the demand for different goods and
services.

(5) Help ● On the basis of CPI of different classes of

businessmen in people, a businessman can make predictions
forecasting about the demand for his products.

Methods of constructing CPI:

Here,

W = Weights

(B) Aggregative expenditure method: P01

= ∑p1q0∑p0q0×100∑p1q0∑p0q0×100
(ii) Wholesale price index (WPI): WPI Indicates the change in the
general price level.
(iii) Index of industrial production (IIP): IIP is used to measure the
relative increase or decrease in the level of industrial production.
IIP= ∑[q1q0×100]W∑W∑[q1q0×100]W∑W

Here, = Level of Production in the current year

= Level of production in the base year

W = Weight
(iv) Index of agriculture production (IAP)
IAP is used to study the rise and fall of the yield of principle crops from
one period to other period.
(v) Sensex: Sensex is the short form of Bombay stock exchange
sensitive index with 1978-79 as base. It is the benchmark index for the
Indian stock market.
It consists or 30 stocks which represent 13 sectors of the economy
and the companies are the leaders in their respective industries.
Problems in construction of index numbers:
(i) Purpose of index number.
(ii) Selection of base year.
(iii) Selection of items.
(iv) Selection of the prices of items.
(v) Selection of method of weighting
(vi) Selection of sources of data
(vii) Choice of an average.
(viii) Choice of method.
Uses of index numbers:
(i) To measure the purchasing power of money.
(ii) Knowledge of change in standard of living.
(iii) Adjustment in salaries and allowances.
(iv) Help in framing suitable policies.
(v) As economic barometers.

CONSUMER PRICE INDEX

Consumer Price Index or CPI as it is commonly called is an index

measuring retail inflation in the economy by collecting the change in
prices of most common goods and services.

Consumer Price Index or CPI as it is commonly called is an index

measuring retail inflation in the economy by collecting the change in
prices of most common goods and services used by consumers. Called
market basket, CPI is calculated for a fixed list of items including
 food, housing, apparel, transportation, electronics, medical care,
education, etc. Note that the price data is collected periodically, and
thus, the CPI is used to calculate the inflation levels in an economy.
This can be further used to compute the cost of living. This also
provides insights as to how much a consumer can spend to be on par
with the price change.
Remember, CPI is different from WPI, or Wholesale Price Index, which
measures inflation at the wholesale level.
What goods and services are included in CPI?

The CPI measures costs in these areas, according to the BLS:

 Food and Beverages (breakfast cereal, milk, coffee, chicken, wine, full
service meals, snacks)
 Housing (rent of primary residence, owners' equivalent rent, fuel oil,
bedroom furniture)
 Clothes (men's shirts and sweaters, women's dresses, jewelry)
 Transportation (new vehicles, airline fares, gasoline, motor vehicle
insurance)
 Medical Care (prescription drugs and medical supplies, physicians'
services, eyeglasses and eye care, hospital services)
 Recreation (televisions, toys, pets and pet products, sports equipment,
admissions)
 Education and Communication (college tuition, postage, telephone
services, computer software and accessories)
 Other Goods and Services (tobacco and smoking products, haircuts
and other personal services, funeral expenses)

Also included within the major groups listed above are various
government-charged user fees, such as water and sewerage charges,
auto registration fees, and vehicle tolls. Also, the CPI includes sales
and excise taxes associated with purchases.
How does Consumer Price Index help?
The Reserve Bank of India and other statistical agencies study CPI so
as to understand the price change of various commodities and keep a
tab on inflation. CPI is also a helpful pointer in understanding the real
value of wages, salaries and pensions, the purchasing power of a
country’s currency; and regulating prices.
Economists are in charge of collecting data by surveying households
on their buying patterns, most purchased items, and daily expenses.
Who maintains Consumer Price Index in India?
In India, there are four consumer price index numbers, which are
calculated, and these are as follows:
 CPI for Industrial Workers (IW)
 CPI for Agricultural Labourers (AL)
 CPI for Rural Labourers (RL) and
 CPI for Urban Non-Manual Employees (UNME).
While the Ministry of Statistics and Program Implementation collects
CPI (UNME) data and compiles it, the remaining three are collected by
the Labour Bureau in the Ministry of Labour.
How is Consumer Price Index calculated?
The CPI is calculated with reference to a base year, which is used as a
benchmark. The price change pertains to that year. Remember, when
you calculate the CPI, note that the price of the basket in 1 year has to
be first divided by the price of the market basket of the base year.
Then, it is multiplied by 100.
Consumer Price Index formula:
CPI = (Cost of basket divided by Cost of basket in the base year)
multiplied by 100

What is Wholesale Price Index (WPI)?

Wholesale Price Index meaning: WPI measures the changes in the
prices of goods sold and traded in bulk by wholesale businesses to
other businesses.

Wholesale Price Index

 It measures the changes in the prices of goods sold and traded in

bulk by wholesale businesses to other businesses.

 Published by the Office of Economic Adviser, Ministry of

Commerce and Industry.

 It is the most widely used inflation indicator in India.

 Major criticism for this index is that the general public does not
buy products at wholesale price.

 The base year of All-India WPI has been revised from 2004-05 to
2011-12 in 2017.

T++he main uses of WPI are the following:

1. to provide estimates of inflation at the wholesale transaction

level for the economy as a whole. This helps in timely
intervention by the Government to check inflation in particular,
in essential commodities, before the price increase spill over to
retail prices.

2. WPI is used as deflator for many sectors of the economy

including for estimating GDP by Central Statistical Organisation
(CSO).

3. WPI is also used for indexation by users in business contracts.

4. Global investors also track WPI as one of the key macro

indicators for their investment decisions.
.

Difference between WPI and CPI

WPI measures the average change in prices of goods at the wholesale
level while CPI calculates the average change in prices of goods and
services at the retail level.
WPI data is published by the Office of Economic Adviser, Ministry of
Commerce and Industry, while CPI data is published by the National
Statistical Office (NSO), Ministry of Statistics and Programme
Implementation (MoSPI).
The base year for WPI is 2011-12 while the base year for CPI is 2012.
WPI takes into account the change in price of goods only, while CPI
takes into account the change in process of both goods and services.

INFLATION

Inflation is the rate of increase in prices over a given period of time.

Inflation is typically a broad measure, such as the overall increase in
prices or the increase in the cost of living in a country

 Inflation is the rate at which the value of a currency is falling

and, consequently, the general level of prices for goods and
services is rising.
 Inflation is sometimes classified into three types: Demand-Pull
inflation, Cost-Push inflation, and Built-In inflation.
 The most commonly used inflation indexes are the Consumer
Price Index (CPI) and the Wholesale Price Index (WPI).
 Inflation can be viewed positively or negatively depending on the
individual viewpoint and rate of change.
 Those with tangible assets, like property or stocked
commodities, may like to see some inflation as that raises the
value of their assets.