Page 271 - DECO504_STATISTICAL_METHODS_IN_ECONOMICS_ENGLISH

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

Precautions while using Consumer Price Index of Cost of Living Index Notes

Quite often the consumer price indices are misinterpreted. Hence while using these indices the
following points should be kept in mind
1. As pointed out earlier the consumer price index measures changes in the retail prices only in
the given period compared to base period —it does not tell us anything about variations in
living standard at two different places. Thus, if the cost of living index for working class for
Mumbai is 175 and Delhi 150 for the same period and for the same class of people, it does not
necessarily mean that living costs are higher in Mumbai as compared to Delhi.
2. While constructing the index it is assumed that the quantities of the base year are constant and
hold good for current year also. But this assumption does not appear to be very logical because
the pattern of consumption, goes on changing with the change in fashion, introduction of new
commodities in the market, etc. It is desirable, therefore, that while constructing the index the
current year quantities are taken into account. But this is a difficult task. The Sixth International
Conference of Labour Statisticians recommended that the pattern of consumption should be
examined and the weights adjusted, if necessary, at intervals of not more than ten years to
correspond changes in the consumption pattern. The index also does not take into account
changes in qualities. Unlike changes in consumption pattern changes in qualities of goods and
services are more frequent and when a marked change in the quality of items occurs appropriate
adjustment should be made to ensure that the index takes into account changes is qualities also.
But in practice it is a difficult proposition to follow and, therefore, constant qualities are assumed
at two different dates which again is a shaky assumption.
3. Like any other index the consumer price index is based on a sample. While constructing the
index, sampling is used at every stage in the selection of commodities, in obtaining price
quotations, selecting families for family budget enquiry, etc. The accuracy of the index thus
hinges upon the use of sampling methods. The consumption pattern derived from the
expenditure data of a sample of households covered in the course of family budget enquiry has
to be representative of all the items in the average budget, the localities from which price data
are collected have to be representative of all the localities from which the population group
make purchases, the retail outlets from which prices are collected have to be representative of
all the retail outlets patronised by the population group, etc. However, it is often difficult to
ensure perfect representativeness and in the absence of this the index may fail to provide the
real picture.
Example 4: The following are the group index numbers and the group weights of the budget of
an average working class family. Construct the cost of living index number.
Group Index Weight

Food 352 48
Fuel and Lighting 220 10
Clothing 230 8
Rent 160 12
Miscellaneous 190 15

Solution:

Construction of Cost of Living Index
Group Index Weight IW
I W
Food 352 48 16,896
Fuel and Lighting 220 10 2,200

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