What are the uses of Index Numbers?

Various uses of index numbers 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 measure of relative change in the value added by a variable or a group of related variables over time or space.

Characteristic of an Index number

  1. Index numbers are expressed in percentages.
  2. Index numbers are comparable nature at any two timing or places.
  3. Index numbers are a sort of averages, usually weighted averages.
  4. 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 described as follows

  1. An Aid to Framing of Policies

Fixing of wages and dearness allowance is mainly based on 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 getting salary 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 index number is to measure the cross-sectional changes at a point of time over 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.

Coefficient of Variation Example

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 also applicable to index numbers some formulas will leads into upward bias and others leads into downward bias.

Different types index numbers mentioned as below.

  • Price Index Number

The most commonly used index number is price index number. Price index number measure the general changes in the retails or wholesale prices of a commodity or a group.

  • Quantity Index Number

Quantity index number which measures these the changes occurring in the quantity of goods demand, consumed production, import export etc.…

  • Consumer Price Index

In other words, it’s known as cost-of-living index. Consumer price index constructed for the prices of only the essential items

  • Value Index

This is used for total value of certain items at a point of time compared to 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 given year method index. Paasche’s have a downward bias.

Other major formula’s 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.

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