Major Problems in the Construction of Index Numbers

Index numbers are commonly used in considering the market state of said region. Because expenditures fluctuate across cities and countries, an index number is of little use in comparing price increases. As a result of their effectiveness in gauging the extent of economic changes over a given time, index numbers hold a prominent position. 

Given its drawbacks, an index is the simplest way to measure short-term fluctuations in the price levels of the commodity chosen.

Different methods of constructing index numbers

A simple index number is an integer that determines the relative shift in a single change in relation to a foundation. Index numbers of such a type are composed of a single item.

Weighted index numbers are index numbers wherein the logical weights are explicitly allocated to distinct networks.

Difficulties faced in the Construction of Index Numbers

The production of index numbers is fraught with challenges. Following are the difficulties faced in the Construction of Index Numbers –

1. Difficulties in Choosing a Base Period:

The first challenge is determining which year to use as the starting point. The foundation year must be standard. However, determining a causal year is tough. Furthermore,  a typical year now becomes abnormal after a certain amount of time. As a result, having the same base period for several years is not recommended.  

2. Problem in Commodity Selection:

Another challenge is selecting the index number’s representative commodities. The selection is not a simple task. They must be chosen from a diverse range of things that are consumed. Consumer consumption patterns may change, rendering the number of indexes obsolete. As a result, selecting representative commodities involves significant challenges.

3. Problems in Price Compendium:

Another challenge is obtaining enough and correct value. It’s not always possible to obtain from the same location. Furthermore, the issue of deciding middle prices arises. The retail cost differs greatly. As a result, wholesale prices are calculated using index numbers.

4. Difficulty in Choosing a Statistical Approach:

Another challenge is deciding on a suitable approach for calculating averages. However, each strategy produces a unique set of findings. As a result, deciding which strategy to use is challenging.

5. Difficulties Resulting from Changes Over Time:

In today’s world, changes in commodities occur on a continuous basis because of technological advancements. So, consumers begin to consume them, and instead of the old, new commodities are introduced. Furthermore, commodity prices may fluctuate because of technological advancements. They might fall. However, when calculating the index numbers, new commodities are not added to the list of commodities. As a result, the index figures based on ancient commodities are unreal.

6. It is not possible to make a comparison:

Index numbers do not allow for international pricing comparisons. The goods consumed and included in the calculation of an index number vary by country. Meat, eggs, automobiles, and electrical appliances, for example, are included in advanced countries’ price indices but not in backward countries. Similarly, the weights allocated to goods differ. As a result, international comparisons of index numbers are impossible.

7. It is not possible to make comparisons between different locations:

Even if various locations within a country are chosen, the same index number cannot be assigned to them. This is due to variances in people’s consumption habits. Individuals in the northern part of India consume different commodities than people in the southern portion of India. As a result, applying the same index number to both is incorrect.

8. Not Appropriate to Individuals:

An index number is not applicable to a single person who is a member of the group it was created. A person may not be affected if there is a rise in the price level index number shows. This is since an index number reflects averages.

Precautions to be taken while constructing an index number

The first step is to receive a price quotation for the goods that have been chosen. We all know that the cost of various goods differs from one location to the next and even from one store to the next within the same market. It’s also necessary to decide if wholesale or retail pricing is required. The decision would be based on the index number’s intended use.

The selection of an appropriate base year is another precaution in the production of an index number. The base year serves as a point of reference for comparisons. A regular year should be used as the basis year. It should be free of anomalies such as wars, earthquakes, and other natural disasters.

The next care to be considered while building the index number is to consider the purpose of the index number. When a value index is required, the calculation of a volume index is appropriate. The goods are chosen, and their prices are determined with the help of index numbers.

These are the precautions to be taken when dealing with the difficulties faced in constructing index numbers.

Conclusion

In the above article, we briefly discussed different methods of constructing index numbers, precautions to be taken while constructing an index number and difficulties faced in the Construction of Index Numbers. 

Because of the difficulties faced in constructing index numbers, it is reasonable to conclude that indexes are only approximations for measuring changes in money. These issues, however, become less relevant when indexes are produced for a short period. Since the customs, preferences, production technologies, and commodities enter a price index that doesn’t alter over a short period of time.