Page 254 - DMGT404 RESEARCH_METHODOLOGY

Research Methodology

Notes 11.7 Problems in the Construction of Index Numbers

The following are some general problems that are faced in the construction of any index number:
1. Definition of the purpose: Since it is possible to construct index numbers for a number of
purposes and one cannot have an all purpose index, therefore, it is very essential to define
the specific purpose of its construction. For example, if we are interested in the construction
of a price index number, we must have knowledge about the purpose to be served by it,
i.e., what is to be measured by it; like the cost of living of workers or the change in
wholesale prices, etc. In the absence of this information, it may be difficult to carry out
various steps in the construction of an index number. The questions like what are items to
be included, from which of the markets the price quotations are to be obtained, what will
be the weights of different items, etc., cannot be answered unless the purpose of the index
number construction is known. Further, an index number can be of sensitive or general
nature. In case of sensitive index, only those items are included whose variables (like
prices in case of price index) fluctuate very often; while efforts are made to include as
many items as possible when the index is of general nature. It may be pointed out that the
index numbers are specialised tools and as such are more useful and efficient when properly
used. The first step in this direction is a specific definition of the purpose of its construction.
2. Selection of the base period: Every index number is constructed with reference to a base
period. There are two important points that must be kept in mind while selecting the base
period of an index number.
(a) The base period should correspond to a period of relative economic and political
stability, i.e., it should be a normal or representative period in some way. In certain
situations where identification of such a period is not possible, the average of certain
periods can also be taken as base.
(b) The comparison of current period with a remote base doesn’t have much relevance.
In the words of Morris Hamburg, “It is desirable that the base period be not too far
away in time from the present. The further away we move from the base period the
dimmer are our recollections of economic conditions prevailing at that time.
Consequently, comparisons with these remote base periods tend to lose significance
and become rather tenuous in meaning”.
Another problem with a remote base period can be that certain items that were in
use in the base period are no longer in use while certain new items are in use in
current period. In such a situation the two item bundles are no longer homogeneous
and comparable. This problem is less likely to occur when fairly recent period is
chosen as base.

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Caution The base period should not be too distant from the current period.
3. Selection of number and type of items: An index number of a particular group of items is
in fact based on a sample of items taken from it. It is neither possible nor necessary to
include all the items of the group in the construction of an index number. The number of
items to be included depends largely upon the purpose of the index number.
There are no hard and fast rules that can be laid down with regard to the selection of the
number of items, however, it must be remembered that more is the number of items the
more representative will be the index number and more cumbersome will be the task of
computations. Therefore, it is necessary to have some sort of balance between having a
representative index and the work of computation involved in its construction.

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