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Quantitative Techniques – I

Notes On the basis of the above definitions, the following characteristics of index numbers are worth
mentioning:
1. Index numbers are specialised averages: As we know that an average of data is its
representative summary figure. In a similar way, an index number is also an average,
often a weighted average, computed for a group. It is called a specialised average because
the figures, that are averaged, are not necessarily expressed in homogeneous units.
2. Index numbers measure the changes for a group which are not capable of being directly
measured: The examples of such magnitudes are: Price level of a group of items, level of
business activity in a market, level of industrial or agricultural output in an economy, etc.
3. Index numbers are expressed in terms of percentages: The changes in magnitude of a group
are expressed in terms of percentages which are independent of the units of measurement.
This facilitates the comparison of two or more index numbers in different situations.

10.2 Uses of Index Numbers

The main uses of index numbers are:
1. To measure and compare changes: The basic purpose of the construction of an index number
is to measure the level of activity of phenomena like price level, cost of living, level of
agricultural production, level of business activity, etc. It is because of this reason that
sometimes index numbers are termed as barometers of economic activity. It may be
mentioned here that a barometer is an instrument which is used to measure atmospheric
pressure in physics.

The level of an activity can be expressed in terms of index numbers at different points of
time or for different places at a particular point of time. These index numbers can be easily
compared to determine the trend of the level of an activity over a period of time or with
reference to different places.

2. To help in providing guidelines for framing suitable policies: Index numbers are
indispensable tools for the management of any government or non-government
organisation. For example, the increase in cost of living index is helpful in deciding the
amount of additional dearness allowance that should be paid to the workers to compensate
them for the rise in prices. In addition to this, index numbers can be used in planning and
formulation of various government and business policies.
3. Price index numbers are used in deflating: This is a very important use of price index
numbers. These index numbers can be used to adjust monetary figures of various periods
for changes in prices. For example, the figure of national income of a country is computed
on the basis of the prices of the year in question. Such figures, for various years often
known as national income at current prices, do not reveal the real change in the level of
production of goods and services. In order to know the real change in national income,
these figures must be adjusted for price changes in various years. Such adjustments are
possible only by the use of price index numbers and the process of adjustment, in a
situation of rising prices, is known as deflating.

4. To measure purchasing power of money: We know that there is inverse relation between
the purchasing power of money and the general price level measured in terms of a price
index number. Thus, reciprocal of the relevant price index can be taken as a measure of the
purchasing power of money.

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