What are the uses of Index Numbers?
What are the uses of Index Numbers?, Various uses of index numbers are described in this article. Let’s check what is index number?
Index numbers are also known as economic barometers because they reveal the state of inflation or deflation.
An index number is a measure of relative change in the value added by a variable or a group of related variables over time or space.
Characteristics of an Index number
- Index numbers are expressed in percentages.
- Index numbers are comparable in nature at any two-timing or places.
- Index numbers are a sort of averages, usually weighted averages.
- Index numbers measure the changes in some quantities which cannot be observed directly.
What are the uses of index numbers?
Mainly five uses of index numbers are described as follows
- An Aid to Framing of Policies
Fixing of wages and dearness allowance is mainly based on the consumer price index.
2. To find Trend
Index numbers measure the changes from time to time which enables us to study the general pattern or trend of the economic activity. This can be used for forecasting purposes also.
3. To assess the purchasing power of money
The consumer price index helps in computing the real wages of a person. Suppose one person gets a salary of 2000 Rs in 1980 and 12000 Rs in 2020, basis index number can measure the salary of the person is increased or decreased.
4. For adjusting national income
Index numbers are used for deflating the net national product (NNP) or net national income (NNI).
5. A measure of comparative changes
The main purpose of the index number is to measure the cross-sectional changes at a point of time over a previous time.
The main measures like consumer price index (CPI), Price Index (PI), Price Level (PL), and all measuring based on index numbers.
Index numbers are extensively used in economic analysis. Index number calculating based on sample data, if any sampling error or data collection error will lead to error in index number calculation.
Index numbers are based on different types of averages. It is not possible to say that a particular average is absolutely good or true.
Formula error is also applicable to index numbers some formulas will lead to upward bias and others lead to downward bias.
Different types of index numbers are mentioned below.
- Price Index Number
The most commonly used index number is the price index number. The price index number measures the general changes in the retail or wholesale prices of a commodity or a group.
- Quantity Index Number
Quantity index number which measures the changes occurring in the quantity of goods demand, consumed production, import-export etc.…
- Consumer Price Index
In other words, it’s known as the cost-of-living index. The consumer price index is constructed for the prices of only the essential items
- Value Index
This is used for a total value of certain items at a point in time compared to the base period.
Different types of formulas as mentioned below.
- Laspeyre’s Price and Quantity Index Numbers
Laspeyre’s index is also known as base year method. Laspeyre’s indices have an upward bias.
- Paasche’s Price and Quantity Index Numbers
Paasche’s index is also known as the given year method index. Paasche’s has a downward bias.
Another major formula are stated as below
- Drobish-Bowley Price Index
- Geometric Cross Formula
- Arithmetically Crossed-Weight Formula
- Kelly’s fixed weight Formula
All formulae stand at equal footing based on their own logic.