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Unit 11: Index Numbers
11.2 Uses of Index Numbers Notes
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.
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.
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.
Self Assessment
Fill in the Blanks:
3. Index numbers are termed as ……………….of economic activity.
4. The ………………….can be expressed in terms of index numbers at different points of time
or for different places at a particular point of time.
11.3 Construction of Index Numbers
To illustrate the construction of an index number, we reconsider various items of food mentioned
earlier. Let the prices of different items in the two years, 1990 and 1992, be as given below:
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