Index number is the term used for measuring changes in one or a group of variables concerning time, location, and other factors. As we know, the value of money constantly changes with time and location. The value is, however, inversely proportional to its price. So, we can conclude that if the price level increases, the money value will eventually decrease. Similarly, a decrease in the price level will cause the value of money to increase. This change or variation in the levels of money can be studied under the index number in statistics. The inflation and index numbers are interrelated. As the prices of products increase due to inflation, the CPI (Consumer Price Index) also rises. 

Features of Index Numbers

The basic common features of Index numbers are as follows:

• These are special types of averages used to calculate the relative changes in the level of phenomenon where the calculation of absolute changes is not possible
• Index number helps study changes that are not possible to measure directly
• The method of calculating index numbers varies based on a single or a group of related variables
• They compare the value of certain phenomena on a specific date with some previous date

Types of Index Numbers

There are three basic types of Index numbers. These are as follows:

1. Value Index: The Value Index is the ratio of particular commodities’ aggregate value in the current year and the aggregate value of the given base year. Sales, foreign trades, inventories use the value index number. 
2. Price Index: A Price Index number measures the alteration of prices over a particular period. It compares the current price with the base year to give the variation. It is one of the best index numbers for measuring inflation. Some examples of a price index number include Consumer Price Index and Wholesale Price Index. 
3. Quantity Index: A Quantity Index number measures the quantitative changes in production, consumption, and sold goods within two given years. It shows the changes in quantities of goods over a specific time. It tells us about the output of the economy. An example of a quantity index number is the Index of Industrial Production or IIP. 

Important Index Numbers

It is very necessary to know about the important index numbers in economics. These important index numbers are as follows:

1. Consumer Price Index Number (CPI): 

Different parts of society have many consumption patterns. A Consumer Price Index Number measures consumers’ prices to consume various goods on a monthly basis. It compares the base year’s price to the current year’s price when consumers pay for the goods. Consumer Price Index numbers also reflect lifestyle changes because it shows the changes in the price level throughout the years. As a result, it also affects consumption prices, altering the cost of living. A Consumer Price Index Number generally aims at three sectors: Industrial Workers, Urban Non-Manual Employees, and Agricultural Laborers. 

Ø  Advantages:

Due to the Consumer Price Index functions, it has numerous advantages. Some advantages of CPI are listed below:

• Firstly, it helps the government analyze the risks of elevating prices for development. As a result, it allows the government to increase prices without affecting the cost of living among the masses
• The state government uses the Consumer Price Index to decide wage contracts and additional benefits like dearness allowances for the workers
• Lastly, the CPI also calculates the national income and acts as the income deflator

Ø  Disadvantages:

Although CPI has advantages, it also has some disadvantages or limitations. Listed below are some disadvantages of CPI:

• The first limitation of the CPI is it fails to represent the diversity amongst the masses in various sectors
• The retail price is different for all markets. Therefore, finding one retail price representative of collective retail prices isn’t easy
• Lastly, consumers’ consumption patterns and ratios may change from time to time

Ø  Construction of Consumer Price Index

Listed below are two methods of constructing the Consumer Price index numbers.

•  Aggregative Expenditure Method

Consumer Price Index = (∑P1Q0÷∑P0Q0)*100

In the above formula, ∑P1Q0 indicates the sum of the current year’s prices multiplied by the quantities consumed, and ∑P0Q0 suggests the sum of costs of the base year multiplied by the amounts consumed.

• Family Budget Method

Consumer Price Index =∑RW÷∑W.

In the above formula, ∑RW indicates the sum of the product (R)  and the weight ∑P0Q0 .

 ∑W indicates the importance of all the products. 

2. Wholesale Price Index (WPI)

The Wholesale Price Index measures the changes in retail price every month. Based on monthly indexes, the average annual CPI is calculated. The wholesale price index covers both commodities and services. The products covered by the Wholesale Price Index classify into three categories: Primary articles, fuel now and power, and manufactured goods. 

Ø  Advantages:

• The Wholesale Price Index correctly predicts the demand and supply of products
• The Wholesale Price Index helps in calculating the national income
• The Wholesale Price Index also calculates the rate of inflation

Ø  Disadvantages:

• It is not an ideal benchmark for countries
• The products used for calculating WPI in different countries vary 
• The calculation of inflation is not accurate

3. Industrial Production Index (IPI)

This type of index number measures the change of industrial production relative to the base year. It highlights the output more than the cost. Industrial Production Index calculation happens in three industries: manufacturing, mining, and electricity. 

Ø  Construction of Industrial Production Index

Industrial Production Index= (∑RW÷∑W)*100

In the above formula, ∑RW indicates the sum of the ratio of production level- current year to the base year (R)and the weights of the production of the industries (W).

Conclusion 

We can say that Index numbers hold an important position in the economic field. They help calculate changes in some quantity that we cannot directly observe. There are three basic types of index numbers; Value index, quantity index, and Price index. There are further three important index numbers; CPI (consumer price index), WPI (wholesale price index), and IPI (Industrial price index). It also has many limitations: since the chosen commodities have a basis on samples, the selection of the products might be unbalanced.