Meaning and Characteristics of Index Numbers

Introduction: What are Index Numbers?

The nature of variables to changes over a period of time, and index numbers are statistical devices to measure such changes. Usually, the variables in a statistical calculation diverge following a general trend. Index numbers represent this trend of diversion. The index numbers measure an average diversion in the group of related variables over at least two different situations.

• In general, index numbers are used to make a comparison of two variables. The subject of variables may be schools, persons, hospitals, etc. These numbers also measure the change in the valuations of variables, such as the volume of production in different industries, prices of a specified list of commodities, etc.

• Index numbers are expressed in percentage terms usually. The period over which the two calculations of variables are created is known as the base period. The total value in a base period of the index number is given a value of 100.

  For example, if someone wants to check how the value of a variable has changed from 1980 to 2000, then 1980 becomes the base period.

• The index number of any period usually exists as a proportion to the base period. So, if there is an index number 200, it indicates that the value of two times that of the base period.

• There are both price and volume index numbers. Price index numbers measure and allow two prices of certain goods over a period of time. Quantity index numbers measure the change in the volume of a commodity over a certain period. Although price index numbers are more common in economics, volume index numbers are also an important tool to measure the overall changes in the volume of products in an economy or industry.

Example - Graphic illustration of Index Numbers

Features and Characteristics of Index Numbers

Key features and characteristics of index numbers are the following −

• Index numbers are a special kind of average and they are used to measure changes in variables over two certain periods for variables the absolute value of which is not available.

• Index numbers show only a tentative change in measures of two variables. The exact value of these variables is not known and hence they cannot be measured directly.

• The procedure for measuring index numbers differs from one variable to the other related variable.

• Index numbers help in the comparison of a variable at a certain period of time with another value at another period of time.

• Index numbers are a special type of weighted average, and it helps to determine the average of changes between two variables.

• Index numbers are applicable universally and their utility is also applicable everywhere. For example, the index number of price changes can be used in measuring agricultural and industrial production too.

Types of Index Numbers

Depending on the measurement or the variable, there are mainly three types of index numbers. These are the following −

Quantity Index number

Quantity index numbers measure the value of changes in the volume of a particular good or commodity that is produced, sold, and consumed within a certain period of time. It indicates the average change in production or volume of a commodity in a certain period of time. IIP or the Index of Industrial Production is a good example of quantity index numbers.

Price Index Number

Price index numbers indicate the changes in prices of a commodity over a certain period of time. It is a relative and not an absolute number. The Consumer Price Index (CPI) is a good example of Price Index numbers.

Value Index numbers

Value index numbers are ratios of aggregate value at a particular period to that of the aggregate value of the base period. It is widely used to measure the changes in inventories, sales, foreign trade, etc.

Uses of Index Numbers

Index numbers are very important statistical tools for the comparison of two variables at different points in time. For example, human population and the rate of extinction of species are two types of indexes that are used widely.

Standards of living

Index numbers are used to determine the standards of living in comparison to price level changes. It shows whether people’s lifestyle changes with the rising price of products.

Regulation of wages

Index numbers are also used to regulate wages. The government or companies usually resort to index numbers to determine the increase in wages according to the increase in the price level of commodities.

Government policies

Government policies are formed following index numbers. For example, the index number of prices is used to determine the taxes applicable to income and expenses. The stability of the price index related to fiscal and economic policies is dependent on index numbers.

Advantages of Index numbers

• Index numbers can be used for discerning the outcomes of irregular and cyclical forces.

• Index numbers have widespread use in economics as they are a very good way to measure average changes. They help in forming appropriate economic and fiscal policies.

• Index numbers use primary data at different varying prices. So, they are useful in the case of deflation. Index numbers facilitate the transition from normal to real wages.

• Data obtained from Index number analysis can be used as time series data that can be used for future economic and fiscal projects.

• Index numbers can be used to determine the differences in standards of living in different countries to get a projection of the health of the economy.

Disadvantages of Index numbers

• When index numbers are formed based on samples, there is a chance of an error occurring in the calculation of the average. The average found in such a way may be subject to deliberation which causes the errors.

• The calculation of index numbers is based on items. When the items are not in a trend, it may lead to errors. Without a trend, the value of index numbers is thus inapplicable.

• As the calculation of index numbers can be done in different methods, the different values obtained from various processes may create confusion.

• The index numbers show only an approximate value. Moreover, when the comparison spans a palpably longer time, the chances of errors grow manifolds.

• In the case of index numbers, the selection of items from samples may be skewed.

Conclusion

Index numbers are widely used in economics to find average divergences in order to find a trend in the changes of variables. This makes the statistical method a very important tool for economists and researchers. It is a widely used tool in various fields of study, such as marketing, business studies, and econometrics.

FAQs

Qns 1. What are index numbers? Discuss briefly.

Ans. The nature of variables to changes over a period of time, and index numbers are statistical devices to measure such changes. The index numbers measure an average diversion in the group of related variables over at least two different situations.

Qns 2. How many types of index numbers are there?

Ans. There are three types of index numbers - price index value index, and quantity index numbers.

Qns 3. Give any one advantage and one disadvantage of index numbers.

Ans. Advantage − Index numbers use primary data at different varying prices. So, they are useful in the case of deflation. Index numbers facilitate the transition from normal to real wages.

Disadvantage − When index numbers are formed based on samples, there is a chance of an error occurring in the calculation of the average. The average found in such a way may be subject to deliberation which causes the errors.