Page 215 - DECO504_STATISTICAL_METHODS_IN_ECONOMICS_ENGLISH

Unit 15 : Index Number–Introduction and Use of Index Numbers and their Types

(4) As per Patterson, “In its simplest form, an index number is the ratio of two index numbers Notes
expressed as a per cent. An index number is a statistical measure — a measure designed to
show changes in one variable or in a group of related variables over time or with respect to
geographic location or other characteristic.”
From the above definitions it is very clear that the index numbers are specialised averages
designed to measure change in a group of related variables over a period of time.
Features of Index Number

To understand what an index number is the following features are worth considering :
(1) Index numbers are specialised averages,
(2) Index numbers measure the effect of changes over a period of time,
(3) Index numbers measure the net change in a group of related variables.
15.2 Purpose or Use of Index Number

The definitions and features of index number stated above makes it very clear that index numbers
measure changes. In this way they are indispensible fools in the hands of economists and business
analysts who constantly work for change, of course, towards betterment. The various uses of index
numbers are highlighted below :
(1) Index numbers reveal trends and tendencies : The trend of the phenomenon under study can
be obtained by measuring the changes over a period of time. On the basis of this analysis can be
done. For example, by examining the index numbers of industrial production, business activity
etc. their trend can be understood and analysed.
(2) Index numbers help in measuring suitable policies : The above use of index number which
reveals the trends and tendencies help in framing suitable policies so as to achieve the said
goal. For example, by knowing about the rising trend of imports, suitable policy can be
formulated to prevent it.
(3) Index numbers are used in deflating : Index numbers are very useful in deflating i.e., they are
used to adjust the original data for price changes, or to adjust wages for cost of living changes and
thus transform nominal wages into real wages. Moreover nominal income can be transformed
into real income and nominal sales into real sales through appropriate index numbers.
(4) Index number are used in forecasting future economic activity : Along with studying the past
and the present variables of the economy, index numbers are also useful in estimating the future
economic activity. The long-term variations, trends etc. help in estimating the coming problems.
On the basis of the above, it may be concluded that index numbers are strong tools into the
hands of the economists and business analysts with the help of which they can measure changes
in certain phenomenon over a period of time or through a geographical location. This enables
them to form suitable policies to obtain the desired results. Past, present and future trends and
tendencies are revealed with the help of index numbers and they are also useful in deflating. In
the words of Kafka and Simpson, “Index numbers are today one of the most widely used statistical
devices. They are used to feel the pulse of the economy and they have come to be used as
indicators of inflationary or deflationary tendencies.”
Problems in the Construction of Index Numbers
Index numbers are constructed in the form of specialised averages with definite purpose and with
some base period. Before constructing index numbers, it is necessary to know about the various
problems which arise in its construction so that they can be minimised. Some of the important problems
are :
(1) Selection of base period : Base period is the one against which comparisons are made. It may
be year a month or a day. The index for base period is always taken to be 100. It is essential to
choose an appropriate base before constructing index numbers. The base is selected as per the
object of the index, but following considerations should also be made — (a) The base period

LOVELY PROFESSIONAL UNIVERSITY 209