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## Kerala Plus One Economics Notes Chapter 18 Index Numbers

Index Numbers

An index number is a statistical device for measuring changes in the magnitude of a group of related variables. It represents the general trend of diverging ratios, from which it is calculated. It is a measure of the average change in a group of related variables over two different situations. An index number also measures changes in the value of the variables such as prices of a specified list of commodities, the volume of production in different sectors of industry, production of various agricultural crops, cost of living, etc.

Uses of Index Numbers:

- help in the study of trends.
- help in policy formulation.
- useful in measuring the purchasing power of money.
- help in deflating various values.
- act as economic barometers.

Some Important Index Numbers

1. Consumer price index: Consumer price index (CPI), also known as the cost of living index, measures the average change in retail prices. The CPI for industrial workers is increasingly considered the appropriate indicator of general inflation, which shows the most accurate impact of price rise on the cost of living of common people.

2. Wholesale price index: The wholesale price index number indicates the change in the general price level. Unlike the CPI, it does not have any reference consumer category. It does not include items pertaining to services like barber charges, repairing, etc.

3. Industrial production index: The index number of industrial production measures changes in the level of industrial production comprising many industries. It includes the production of the public and the private sector. It is a weighted average of quantity relatives. In India, it is currently calculated every month with 1993 – 94 as the base.

4. Index number of agricultural production: Index number of agricultural production is a weighted average of quantity relatives. Its base period is the triennium ending 1981-82. In 2003-04 the index number of agricultural production was 179.5. It means that agricultural production has increased by 79.5 percent over the average of the three years 1979-80, 1980-81 and1981-82. Foodgrains have a weight of 62.92 percent in this index.

5. Producer Price Index: The producer price index number measures price changes from the producers’ perspective. It uses only basic prices including taxes, trade margins and transport costs.

Issues in the Construction of an Index Number

You should keep certain important issues in mind, while constructing an index number.

1. You need to be clear about the purpose of the index. Calculation of a volume index will be inappropriate when one needs a value index.

2. Besides this, the items are not equally important for different groups of consumers when a consumer price index is constructed.

3. Every index should have a base. This base should be as normal as possible. Extreme values should I not be selected as the base period. The period should be also not belong to too far in the past. The comparison between 1993 and 2005 is much more meaningful than a comparison between 1960 and 2005. Many items in a 1960 typical consumption basket have disappeared at present. Therefore, the base year for any index number is routinely updated.

4. Another issue is the choice of the formula, which depends on the nature of the question to be studied. The only difference between Laspeyres’ index and Paasche’s index is the weights used in these formulae.

5. Besides, there are many sources of data with different degrees of reliability. Data for poor reliability will give misleading results. Hence, due care should be taken in the collection of data. If primary data are not being used, then the most reliable source of secondary data should be chosen.