Inflation and Index Number

Topics: Inflation, Index numbers, Price index Pages: 5 (1584 words) Published: May 25, 2013
An index number is a statistical measure which is designed to express changes in a variable or a group of related variables under two different situations. They are usually expressed in percentage form. The comparisons may be between the periods of time, between places or other characteristics. We can also say that an index number is a number which indicates the level. of a certain phenomenon at any given time in comparison with the level of the same phenomenon at some standard time. They are constructed with reference to a base period and thus very useful in comparing changes over different time periods. For example if we say that index of a certain industry in 2004 was 125 with the base year 2000, it would imply that the production has increased by 25% in 2004 as compared to 2000. Such an index computed for only one item is called a univariate index. If we like to construct an index for the industrial sector as a whole, it will be a composite index because here a number of variables have to be combined. A few definitions of index number are given, below:

1. A special type of average which provides a measurement of relative changes from time to time or from place to place". - Wesell and Willett. 2. "An index number is a stastical measure designed to show changes in a variable or group of related variables with respect to time geographical location or other characteristics such as income, profession-etc."-Spiegel Uses of index numbers

The theory of Index Numbers is widely applied in economics and business. They serve the following purposes. (i) Index numbers are very useful in studying trends of a series over a given period of time and thus facilitates forecasting. (ii) Index numbers provide the basic criteria to make policies. (iii) Index numbers help in measuring the purchasing power of money. (iv) They are used in computing real wages through the process of deflating. (v) Index numbers are Economic Barometers. Indices of prices, output, foreign exchange, bank deposits etc. act as barometers to find out ups and downs in the general economic conditions of a country. Barometers are used to measure atmospheric pressure and index numbers are called economic barometer as they measure the pressure of economic and business behaviour. Index number may be classified in terms of the variables that they measure. They are generally classified into three categories. 1. 'Price Index Number

The most common index numbers are the price index numbers. They study changes in the price level of commodities over a period of time. They are of two types: (a) Wholesale Price Index Number
They depict changes in the general price level of the economy. The first series of the index number was constructed by the Government of India in 1947 with August 1939 as the base year. (b) Retail Price Index Number

They reflect changes in the retail prices of different commodities. They are constructed for different classes of consumers. 2. Quantity Index Number
They reflect changes in the volume of goods produced or consumed. Some of the quantity index numbers are-index number of agricultural production, index numbers of industrial production, indices of exports and imports etc. 3. Value Index Number

They study changes in the total value (Price x quantity), for example, index number of profits or sales is a value index number. Problems in the construction of index numbers
Since the basic approach in the construction of all types of index numbers is the same, we shall discuss the problems of constructing price index. The construction of index numbers involves the consideration of the following' important points. 1. Purpose

There must be precise statement about the purpose of constructing index numbers. All index numbers will not serve the same purpose and there is no all purpose index number the other steps in the construction of index number will mainly depend on the purpose. So, the purpose for which the index number is constructed...
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