An index number is a number that “measures a relative change in a variable or an average relative change in a group of related variables with respect to a base”. An index number indicates the level of certain phenomena at some given period in comparison with the level of the same phenomena at some reference period. The index numbers are usually constructed for economic variables such as price, quantity, wage, unemployment, investment, cost of living, etc.
Index numbers are free from units of measurement because they show relative changes. For ease of understanding, index numbers are expressed in percentages. To construct index numbers at least two periods are required and a period that is economically stable and has no major crisis caused by wars, diseases, strikes, food shortage, etc. known as the normal period is selected as a base. Index numbers of wholesale prices and consumer prices, etc. are published by the Federal Bureau of Statistics and State Bank of Pakistan.
Uses/ Need of Index Number
There are many uses of index numbers but the most important are:
- Many economic plans and Government policies depend on index numbers, for example, to control raising prices government import from the other countries or give subsidy (financial support) to the manufacturer.
- Price index numbers are used to know the purchasing ability of money at different periods and places.
- Quantity index numbers are used to know the changes in the quantities produced, consumed, sold, purchased, imported or exported, etc.
- Consumer price index numbers are used to know standards of living of people and to know about the goods and services used by them.
- Index numbers are used to forecast the future economic trends
- Cyclical (long-term movements, which are in the form of oscillation) and seasonal (short term movement, which are linked with the seasons or movements which repeat themselves within a fixed period) movements are measured by index numbers.
Shortcomings of Index Numbers
Index numbers can not be used freely due to the following shortcomings:
- Improper base period give misleading results. Base periods must be free from all types of crisis caused by wars, diseases, strikes, or food shortage, etc. If such a period is not available then average of some or all the periods is selected as base.
- Selection of favorite commodities is difficult because use of services and commodities by the individuals vary with the locality of people, social customs, standard of living, occupation, ideas of saving, courage of investment and sources of income, etc.
- Quality of a product cannot be observed at each point, that is, ball to ball commentary is difficult. For example, if we want to view the quality of cloth at each thread before purchasing it becomes impossible.
- Index numbers give rough measure of relative changes because sampling error or error of measurement may occur at the stages of gathering of data or base period may be improper or number of commodities may be less than required. According to Dr. Arriving Fisher the accuracy of index numbers may be increased by increasing the number of commodities.
- Different methods of index numbers usually give different results.
- Prices vary from place to place according to idea of profit of investors, expenditures on transportation and awareness about the psychology of buyers, hence their collection is difficult.