Page 216 - DECO504_STATISTICAL_METHODS_IN_ECONOMICS_ENGLISH

Statistical Methods in Economics

Notes should not be a very old period. It must be a fairly recent period, so that comparisons are
between similar set of circumstances. (b) The base period selected should be a normal period
i.e., that period should be free from abnormalities like war, earthquake, boom or depression etc.
(c) It has to be predecided whether fixed base or chain base index has to be prepared. In fixed
base, the base year remains fixed, while in chain-base, the base year for each time period is the
index of the preceeding time period i.e., the base is not fixed, it changes with each time period
(a year, a month a week or a day).
(2) Purpose of Index numbers : While constructing index number the purpose for which it is
constructed must be clearly defined. This is because there are no all-purpose index and every
index is of limited and particular use. Lack of clearity of purpose would lead to confusion and
wastage of time with no fruitful results.
(3) Selection of number of items : To study the change in a certain phenomenon, it is not possible
to include each and every item leading to change. For example, while constructing price index,
change in price of each and every item cannot be included. The selection of commodities should
be such that they are representative of the tastes, preferences and habits etc. of the group of
people regarding whom the index is constructed. In this way, it becomes a big problem as to
which items to be included and which to be excluded ? Again, by having purpose of index
properly defined, the selection of items can be eased. Index numbers would give false results if
at one time one set of quantities are used and at other time other set of quantities are used.
(4) Choice of average : Another problem faced while constructing an index is the decision as to
which average, mean, median, mode, geometric mean or harmonic mean, should be used for
constructing the index. Each one has its own advantages and drawbacks. Theoretically, geometric
mean is considered to be most suitable because of the following reasons — (a) While constructing
index numbers ratios of relative changes are taken into consideration and geometric mean
gives equal weights to equal ratio of change, (b) index numbers that use geometric mean can be
reversed which makes base shifting easily possible, (c) geometric mean is not influenced much
by violent fluctuations in the values of individual items. However, use of arithmetic mean is
also popular because it is simpler to compute than geometric mean.
(5) Selection of appropriate weights : The term ‘weight’ refers to the relative importance of the
different items in the construction of the index. All items are not of equal importance and hence
it is necessary to device some suitable method which is done by allocating weights. In case of
weighted indices, specific weights are assigned. Implicit or explicit methods of assigning weights
can be used. Quantity or value weights can be assigned. If aggregative method is used, quantities
are used as weights and in averaging of price relatives method of constructing index, value
weights are used. Moreover, it has to be decided whether the weights would be fixed or
fluctuating. In this way selection of appropriate weights forms a very crucial problem in
constructing index.
(6) Selecting appropriate formula : There is a large range of formulae available to construct index
numbers. Choosing among these to prepare index is another problem while constructing index
numbers. The choice of formula should depend not only on purpose but also on the availability
of the data. Theoretically, Fisher’s method is the ‘ideal’ method for constructing index numbers.
However, depending upon the purpose and availability of data, other methods may also be
used.
(7) Obtaining quotations : The change in the level of certain phenomenon can be measured only
when proper data regarding quotations is available. For example, while preparing price index,
it is essential to obtain proper price quotations of the selected commodities. Or while preparing
expenditure index, information about expenditure should be available. In the absence of real
information, the results may be misleading. This poses to be another problem while constructing
index numbers.
On the basis of the above it can be said that most of the problems arise as a result of availability
of alternatives. That is, in the presence of alternatives it becomes difficult to choose the best
possible alternative, for example, which average to use, which method to weight must be used,

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