Index Numbers

EconomicsArticles / Tutorial Titles

Introduction

The index numbers define the levels of variables in regard to a particular period of time span.

Although index numbers are statistical in nature, they are used widely in economics and other subjects. In economics, index numbers play a pivotal role to express various factors’ changes’ effects in real terms.

What is an Index Number?

Index numbers measure the change in a variable or group of variables with the change in time, geographic location, and other such features. Index numbers show a general relative change and they are not expressed as a direct measurable figure. Index numbers are very important in the study of economics. Thus, we can study the change in the effects of all variable factors that cannot be directly measured with the help of index numbers.

Therefore, index numbers represent the changes’ effects that cannot be calculated directly. Index numbers are expressed in percentage form.

The main characteristics of index numbers are as follows:

  • Index number is a form of average that measures relative changes in the instances where absolute measurement is not possible.

  • Index numbers are helpful in the comparison of the levels of a criterion concerning a specific time (date) and that of a previous date.

  • Index number represents a particular case of averages, especially a weighted average.

  • Index number shows only the tentative changes in relative factors that cannot be directly measured. It just gives a general idea of the average relative changes

  • The method of index numbers changes from one particular variable to another related one.

  • Index numbers have universal utility. The index number used to measure the changes in price can also be utilized for agricultural and industrial production.

Types of Index Numbers

Price Index

A price index is a measure of changes in price across a given period. It indicates only the relative value and not the absolute value. The Wholesale Price Index (WPI) and Consumer Price Index (CPI) are the major examples of price indexes.

Value Index

A value index is the ratio of the aggregate value for a particular period to that of the aggregate of the base period. It is used for sales, inventories, and foreign trade, among others.

Quantity Index

A quantity index number measures changes in the number or volume of goods that are consumed, produced and sold within a given period. It indicates the relative change of quantity across a period for provided quantities of goods. The Index of Industrial Production (IIP) is an example of a Quantity Index.

Significance of Index Numbers in Economics

Index numbers play very significant roles in economics. Some of the importance roles are as follows:

  • Used to study trends − Index numbers can be used to study trends. As the index numbers show the average tendencies of changes, they can be used to predict future trends.

  • Used to form guidelines − Index numbers are used by policymakers to form guidelines related to agricultural & industrial policies, fixation of wages, etc.

  • Used for forecasting economic activities − Index numbers can be used for forecasting future economic activities because they help in prediction based on past and present data. By using these past and present data, future conditions can be projected with optimum accuracy.

  • Used to measure Inflation − Index numbers can be used to measure inflation by comparing the price-level changes taking place in the markets. Therefore, index numbers help in taking anti-inflationary measures. Moreover, governments pay Dearness Allowance to employees based on the dearness index.

  • Used to express current financial data − Index numbers are used to express current financial data in real terms. Deflating results in making changes to financial data, such as wage changes and price changes which can be used to present financial data in real terms.

Benefits of Index Numbers

The benefits or advantages of Index numbers are related to their utilities. Some common advantages are as stated below.

  • Index numbers adjust primary data at changing costs, which can be instrumental in deflation. It helps the nominal wage to transform into real wages.

  • Index numbers find extensive usage in economics as they help in the framing of effective and conducive policies. The findings help in the establishment of research too.

  • Index numbers help in measuring and understanding trends such as inferring outcomes for irregular and cyclical forces.

  • Index numbers are leveraged for studies of the future development of economic activities. Such time series analyses are utilized for the determination of cyclical developments and future trends

  • The number can be used to measure the changes that take place in the standard of living in different countries over a given period of time.

Limitations of Index Numbers

Although there are specific advantages of Index numbers; however, there are some limitations too. Some of the limitations of index numbers are as follows:

  • There are chances for erroneous outcomes if index numbers arise as a result of samples. As samples are compiled after deliberation, chances for errors creep up. Errors can also take place in the cases of weights or base periods etc.

  • The index numbers generally express the approximate indications of the relative changes. These changes in variables used in comparison over a long-term period may not be fully reliable.

  • It is always measured depending on the items. Items that are selected in the analysis may not accurately be in trend. This in turn provides an inaccurate analysis.

  • There is a chance of the selection of given commodities being skewed as these commodities are dependent on samples.

  • Multiple methods can be used to measure or formulate the same index numbers. Due to this choice of methods, results may vary and offer different sets of values which may be confusing.

Index Number Problem

While the consumer price index (CPI) is a traditional method to measure inflation, it doesn't indicate how these price changes directly change or affect all consumer purchases of commodities and services. It will either understate or overstate cost-of-living increments. This limitation of the CPI is described as the index number problem.

There is no theoretical or practical ideal solution to this problem. In practice, however, for retail price indices, the "basket of goods" is updated increasingly every few years to reflect the occurring changes. However, the fact that many economic indices taken over the long term are not really like-for-like comparisons stays intact and this is an issue considered genuinely by economic history researchers.

Conclusion

Index numbers play a pivotal role in economics and they are the representatives of various effects of changes that cannot be expressed directly by any measure. In this sense, index numbers are not replaceable by any other indicator. That is why the importance of Index numbers stays intact even when there are various other measures in economic research.

However, since indexes can be erroneous in nature, attention must be paid to evaluating them correctly. There are many indices available in the market that represent various commodities and services on a daily basis. The importance of index numbers can be realized from this point.

FAQs

Q1. What is meant by an Index Number in general?

Ans. An index number is an economic figure (data) showing a price or quantity compared with a base value. The base or standard usually equals 100 while the index number is generally expressed as 100 times the ratio to the base value.

Q2. What does an index number measure?

Ans. Index number measures the changes in variables or variables over time.

Q3. How is an index number indicated?

Ans. Index numbers are shown in percentage terms but the percent sign is not shown usually.

raja
Updated on 13-Oct-2022 11:19:47

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