Index number measures the relative difference in the group of variables with respect to time, geographical location, etc. Index numbers are expressed in terms of percentage, shows relative measurement of group of items which helps in the comparison of different items.
There are two methods of constructing an index number: (i) Unweighted Index Number and (ii) Weighted Index Number. Unweighted index numbers include simple aggregative and simple average of price relatives where as weighted index numbers include weighted aggregative and weighted average of price relatives
Simple aggregate index numbers calculate price changes for a number of related items over time.
Simple Average of Price Relatives method is used when prices of different commodities are expressed in different units such as Kg, Litre, Meter etc.
Weighted Aggregative Method involves the assignment of weights to different commodities according to their importance.A weighted aggregative price index using base period quantities as weight is Laspyre’s price index. A weighted aggregative price index using current period quantities as weights is Paasche’s price index.
Weighted Average of Price Relatives is the weighted index of price relatives.
In economics and business index numbers can broadly classified as Price Index Number, Production Index Number and SENSEX.
Price Index Number helps in comparing prices for different commodities over a period of time. It includes Consumer Price Index (CPI) and Wholesale Price Index (WPI)
Production Index Number shows growth of economy in different occupational sectors like primary, secondary and tertiary sectors. It includes Index Number of Agricultural Production (IAP) and Index Number of Industrial Production (IIP)
Rise or fall in SENSEX reflects the health of an economy.
The various uses or importance of Index numbers are: It helps in measuring fluctuations over a period of time, forecasting events, comparing prices of different commodities etc.
CPI is used to formulate price policy, wage adjustment, taxation etc. WPI measures inflation. IIP measures changes in production and industrial growth.
In the construction of a purposeful index number, one should keep certain important issues in mind they are: purpose of constructing the index number, selection of base year, selection of commodities to be included in the index number and selection of formula of calculating the index numbers.