Page 267 - DECO504_STATISTICAL_METHODS_IN_ECONOMICS_ENGLISH

Unit 21: Cost of Living Index and Its Uses and Limitations of Index Numbers

(3) Obtaining price quotations: The collection of retail prices is a very important and, at the same Notes
time, very tedious and difficult task because such prices may vary from place to place, shop to
shop and person to person. Price quotations should be obtained from the localities in which the
class of people concerned reside or from where they usually make their purchases. Some of the
principles recommended to be observed in the collection of retail price data required for purposes
of construction of cost of living indices are described below
(a) The retail prices should relate to a fixed list of items and for each item, the quality should
be fixed by means of suitable specification.
(b) Retail prices should be those actually charged to consumers for cash sales.
(c) Discount should be taken into account if it is automatically given to all customers.
(d) In a period of price control or rationing, where illegal prices are charged openly, such
prices should be taken into account along with the controlled prices.
The most difficult problem in practice is to follow principle (a), i.e., the problem of keeping the weights
assigned and qualities of the basket of goods and services constant with a view to ensuring that only
the effect of price change is measured. To conform to uniform qualities, the accepted method is to
draw up detailed descriptions for specifications of the items priced for the use of persons furnishing
or collecting the price quotations.
Since prices form the most important component of cost of living indices, considerable attention has to be
paid to the methods of price collection and to the price collection personnel. Prices are collected usually by
special agents or through mailed questionnaire or in some cases through published price lists. The greatest
reliance can be placed on the price collection through special agents as they visit the retail outlets and
collect the prices from them. However, these agents should be properly selected and trained and should
be given a manual of instructions as well as manual of specifications of items to be priced.

Appropriate methods of price verification should be followed such as ‘check pricing’ in
which price quotations are verified by means of duplicate prices obtained by different
agents or ‘purchase checking’ in which actual purchases of goods are made.

After quotations have been collected from all retail outlets an average price for each of the items
included in the index has to be worked out. Such averages are first calculated for the base period of
the index and later for every month if the index is maintained on a monthly basis. The method of
averaging the quotations should be such as to yield unbiased estimates of average prices as being
paid by the group as a whole. This, of course, will depend upon the method of selection of retail
outlets and also the scope of the index.
In order to convert the prices into index numbers the prices or their relatives must be weighted. The
need for weighting arises because relative importance of various items for different classes of people
is not the same. For this reason, the cost of living index is always a weighted index. While conducting
the family budget enquiry the amount spent on each commodity by an average family is ascertained
and these constitute the weights. Percentage expenditures on the different items constitute the
individual weights’ allocated to the corresponding price relative and the percentage expenditure on
the five groups constitute the ‘group weight’.
Methods of Constructing the Index

After the above mentioned problems are carefully decided the index may be constructed by applying
any of the following methods:
(1) Aggregate Expenditure Method or Aggregative Method; and
(2) Family Budget method or The Method of Weighted Relatives.
1. Aggregate Expenditure Method: When this method is applied the quantities of commodities
consumed by the particular group in the base year are estimated which constitute the weights.
The prices of commodities for various groups for the current year are multiplied by the quantities

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