Issues In Constructing Index Numbers

Introduction

Index Numbers measure the relative changes in groups of variables or a single variable over time, depending on various factors. Index numbers are an essential part of statistics and economics. The Government uses it to form policies; the state uses it to determine wage contracts, dearness allowances, and other perks. It plays a crucial role in understanding and analyzing the lifestyle cost of various sections of society. Index numbers also highlight the production, output, wholesale prices, and consumer expenditures. It is of several types. Listed below are the types of Index Numbers:

1. Value Index: A Value Index determines the ratio of relative change in the average value for a specific year to the average value of the base year. Inventories, Foreign trades, sales use the value index.

1. Quantity Index: A Quantity Index determines the ratio of the changes in the production, consumption, and selling of particular products over a specific period. Index of Industrial Production (IIP) is an excellent example of a Quantity Index. 

1. Price Index: This type determines the price alteration over a stipulated period. It highlights the relative value instead of the absolute value. The Consumer Price Index (CPI) and Wholesale Price Index (WPI) are good examples of Price Index. 

Issues In Constructing Index Numbers 

While constructing Index Numbers, an individual may face numerous issues during the formation process. This article explores the different obstacles that come up during the construction process of the number. Listed below are some problems in constructing index numbers:

1. Assigning Weights: 

• The choice of weights is a vital factor while determining the index number. 
• Allocating different weights to different commodities is entirely arbitrary. 
• There is no specific parameter to determine higher and lower weights for items. It solely depends on the person assigning weights. 
• Various products might have varying weightage for consumers. All goods do not hold the same importance; some may occupy a higher place in a consumer’s lifestyle, while some may occupy a lower position in the consumer’s lifestyle.
•  This arbitrary nature of assigning weights, as a result, causes some difficulties in constructing an index number. 
• Therefore, it is crucial to revise and update the assigned weights from time to time to avoid such problems. 

2. Selection of Base Period: 

• The base period determines the measurement of the price changes in the current year. 
• It is a comparison period based on which the measure of the relative price change occurs. 
• Since the base period is a pretty essential and determining factor of the index number, it must be correct. 
• The chosen base price must be a standard economic period, that is, a period without any natural calamities or financial crises.
•  It must also not be too long ago as trends and patterns of consumers continue to change throughout the years. 

3. Purpose of the Index Number: 

• The index number, once constructed, can be used for only one single goal. Therefore, it is imperative to first determine the purpose of the number before creating it. Once formed, the number does not exhibit any other purpose. 

4. Obstacles in the selection of products: 

• The choice of goods and commodities is not an easy task. 
• There is a vast range of products to choose from in the selection process. 
• It is vital to select items that represent the majority of the consumers. 
• This factor creates a problem because what might be popular among the masses in the past might not be widespread in the current times. 

5. Assigning Price Quotations: 

• Difficulty setting and collecting accurate prices are common during the formation process. 
• It does not come from the same source. 
• There is also a disparity between wholesale and retail prices. There are numerous differences in both these prices. 
• Hence, Price quotations occur based on wholesale prices. 

6. Selection of the method and average: 

• Selection of the ways of the measurement process of the average is quite a difficult task. 
• Many methods determine the averages resulting in multiple results, including the arithmetic mean, mode, median, geometric mean, etc.
• Hence, different outputs of average causes confusion about which one is the standard one and which one to choose. 

7. Changing times:

•  Changes in the value of goods and commodities from time to time are quite common. 
• With the advent of technology and modernization, various new items have come up with the progress of time. 
• The origin of new commodities automatically makes the old products unfashionable or redundant.
•  The recent entities also are not a part of the data preparing the numbers. 
• Therefore, the numbers formed based on the old items automatically become redundant and outdated. 

8. Difficulties in comparison: 

• Comparison of index numbers internationally or in different places is not possible. 
• Commodities used to evaluate the numbers vary from place to place. 
• This factor makes it difficult for comparisons between multiple index numbers to occur.