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The general level of prices changes throughout time, reflecting changes in money’s worth. A statistical instrument known as an ‘index number’ can measure changes in the general level of prices.
An index number is a method for calculating changes in a variable or set of variables through time, space, or other factors. Price index numbers, which measure changes in the general price level (or the worth of money) over time, are one sort of index number.
The price index number represents the average of changes in the prices of representative commodities at one time compared to another time regarded as the base period.
“An index number of prices is a figure displaying the height of average prices at one time compared to the height of average prices at another time that is regarded as the base period”.
Features of Index Numbers
The term “index numbers” refers to a certain form of averaging. Whereas the mean, median, and mode measure absolute changes and are used to compare only series expressed in the same units, index numbers are used to measure relative changes in the level of a phenomenon when measuring absolute change is not possible, and the series are expressed in different types of items.
Index numbers are used to track changes in the effects of elements that cannot be directly quantified. The general price level, for example, is an abstract concept that cannot be measured directly. However, by monitoring relative changes in the price levels of different commodities, index numbers can be used to provide an understanding of relative changes in the general level of prices.
Index numbers are a method of tracking changes in a single variable or a group of linked variables. For example, the price of milk could be a single variable, but the price of cheese, yoghurt, and curd could be a collection of variables.
The index numbers approach is used to compare the levels of a phenomenon on one date to their levels on another date (for example, the country’s GDP calculation) or the levels of a phenomenon at different locations on the same day.
Importance of Index Numbers:
Common uses
In general, index numbers are quite useful in a variety of situations:
(a) They track changes in a single variable or a set of variables.
(b) They aid in comparisons between different places or periods of time
(c) They aid in the simplification of complex facts.
(d) They aid in future forecasting
(e) They are extremely beneficial in both academic and practical research.
Calculating the value of money.
The use of index numbers to track changes in the value of money or the price level over time is common. Price changes have an impact on the country’s production and employment, as well as different segments of society.
The price index statistics can also forewarn the government about potential inflationary trends, allowing it to take necessary anti-inflationary actions.
Calculating changes in the cost of living
The changes in the country’s cost of living are reflected in the index figures. They show whether people’s living costs are rising or declining. Workers’ pay can be changed based on this information to protect wage earners from the effects of inflation.
Predicting production trends
Index numbers can also be used to provide data on production patterns in various sectors of the economy. They aid in determining the current state of various industries, such as whether the output is expanding, declining, or remaining steady.
Obtaining knowledge about the trade conditions
Knowledge of trade conditions and trends can be gained using index numbers. The import and export indices reveal whether a country’s overseas trade is expanding or declining, as well as whether the trade balance is favorable or unfavourable.
Formulation of economic policy
The government can use index numbers to formulate and evaluate policies. Index numbers track changes in the economy and aid planners in developing suitable policies. Index numbers are also used to determine whether a specific economic policy is beneficial or harmful.
Special relevance in the economic field
Index numbers can be used in the economic field in several ways. They’re helpful in analysing commodity markets. In the stock market, index numbers can provide information concerning price patterns.
The Railways can obtain information regarding changes in freight movement by using index numbers. Bankers can use index numbers to find out about changes in deposits.
Limitations of Index Numbers:
The limitations of the index numbers are as stated below:-
The index numbers are never 100 percent correct due to the different practical difficulties involved in their calculation.
The index numbers generated for one purpose are not usable for another. Factory workers’ cost-of-living index statistics, for example, cannot be used to measure changes in the value of money among the middle class.
International comparisons using index numbers are unreliable. In creating index numbers, different countries use different base years and contain different commodities with varying attributes.
Index numbers only reveal broad trends by measuring average change. They don’t give you the truth.
The quality of objects is not considered when producing index numbers. It’s possible that an increase in the index is related to an increase in product quality rather than a price increase.
