Uses and Classification of Index Numbers: Introduction, Uses, Advantages

Uses and classification of index numbers: An index is a statistical measure of change in a representative collection of individual data points used in Statistics, Economics, and Finance. These numbers can originate from a range of sources, such as firm performance, prices, productivity, and employment.

Economic indices measure the state of the economy from many angles. It acts as a barometer for determining the worth of money. It provides information on changes in the standard of living and aids the business community in making decisions. It is helpful in determining the premium rate.

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Uses of Index Numbers

Index numbers are used in business, meteorology, labour, and industry. They help compare the total variations in the prices of various commodities when the unit of measurement changes over time and price. Some of the uses of index numbers are listed below.

• Economic parameters
  The index numbers are one of the most effective tools for determining the economy’s pulse. It is used to measure whether the economy is inflating or deflating.
• Measures trends
  Index numbers are commonly used to measure relative changes over time. This allows us to determine the overall trend. For example, the changes in price levels, population, and production are evaluated over time.
• Useful for comparison
  The percentages are used to represent the index numbers. As a result, it is beneficial for comparing and understanding changes between two different times.
• Help in framing suitable policies
  Economic and commercial policies are better framed with index numbers. Consumer price index numbers, for example, are useful in determining the amount of dearness allowance given to employees.
• Useful in deflating
  Price index numbers are used to link the original data with price fluctuations. The price index determines the purchasing power of a monetary unit.
• Compares standard of living
  The cost of living index of various periods and locations will assist us in comparing people’s living standards. As a result, the government can enact appropriate welfare measures.
• Special type of average
  All of the basic ideas of averages are used for the construction of index numbers. The data in averages are homogenous (measured in the same units), while in index numbers, we average variables measured in various units. As a result, it is a unique form of average.

Advantages of Index Numbers

One of the most extensively used statistical methods is the index numbers. The following are some of the benefits or applications of index numbers:

1. In formulating policies
   The index numbers drive the majority of economic and corporate decisions and policies.
   Example:
   • The government uses the cost-of-living index to increase DA.
   • The government uses their respective index numbers to establish any policy relating to industrial or agricultural production.
2. In the study of trends
   Index numbers help analyse trends in variables such as export-import, industrial and agricultural production and share prices.
3. In forecasting
   Index numbers are useful not only to analyse past and current behaviour but also to forecast economic and business actions.
4. Facilitates comparative study
   Index numbers become especially helpful when making comparisons over time and space, especially when the units are different. For example, the changes in industrial production can be compared to changes in agricultural output using these numbers.
5. Maintain a standard of living
   Cost inflation index numbers, for example, can be used to compare the purchasing power of money in different locations at different eras. This type of analysis helps the government formulate policies that will maintain or improve the people’s standard of living.
6. Act as an economic barometer
   Index numbers are valuable in determining a country’s economic and corporate activity level. As a result, these are appropriately referred to as economic barometers.

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Classification of Index Numbers

The classifications in economics and business are as follows.

Price Index Numbers

It measures the overall changes in the retail or wholesale price level of a specific or group of commodities.

• Retail Price Index Numbers
  The retail price index tracks the change in average prices over a set period of time. The measurements are obtained by recording the essential goods and services that people are expected to purchase and placing them in a fictitious shopping basket known as the “Basket of Goods.”
• Consumer Price Index Numbers
  A consumer price index (CPI) tracks changes in the prices of a basket of goods and services purchased by households. CPI measures changes in the price level for a specific group of consumers in a given region. CPI can be calculated for industrial, city, and agricultural workers.
• Wholesale Price Index Numbers
  The WPI, or Wholesale Price Index, is the price of a representative basket of wholesale goods. The wholesale price index number represents the change in the overall price level. It lacks a reference consumer category, unlike the CPI. WPI with \(2011\) as a baseline is \(156\) in March \(2014\), implying that the general price level has risen by \(56\% \) during this time.
• Industrial Price Index Numbers
  The industrial production index measures the change in the level of industrial production over a given time period across a variety of industries. It is based on a weighted average of quantity relatives.

Value Index Numbers

The value index number compares the current year’s price of a commodity to the previous year’s price.

Quantity Index Numbers

These are indices used to track changes in the number of goods produced in a factory.

Special Purpose Index Numbers

• Volume Index Numbers
  A volume index or quantity index is a numerical time series measure used to compare how the production of a particular class of goods and/or services varies over time or geographical location.
• Cost of living Index Numbers
  These are structured to investigate the impact of changes in the price level on the cost of living for various classes of people.
• Simple Index Numbers
  A simple index number is defined that determines the relative change of a single variable with respect to a base.
• Composite Index Numbers
  A composite index number is a number that measures the variation in the value of a composite number, which is defined as the sum of a set of elementary numbers.

Solved Examples – Uses and Classification of Index Numbers

Below are a few solved examples that can help in getting a better idea.

Q.1. What are the uses of index numbers?
Ans:
We can calculate a single measure of change for a large number of items using an index number. The index numbers are required for both general and specific purposes.

• Changes in the price level or the value of money are measured. The index number measures the value of money over different time periods.
• The foreign trade information index of export and import provides information about foreign trade that aids in formulating export and import policies.
• Measuring and comparing output, the Industrial Production (IIP) index provides a quantitative figure for the change in production in the industrial sector, allowing us to compare industrial output over time.
• Government policy-making can decide the monetary and fiscal prices and takes necessary steps to develop the country with the help of index numbers.
• Stock Price Indices Sensex and NIFT are index numbers for BSE and NSE share prices. They are an excellent resource for stock market investors.

Q.2. What does a consumer price index for industrial workers measure?
Ans:
The consumer price index for industrial workers measures the average change in retail prices of a basket of commodities that an industrial worker consumes on a regular basis. The consumer price index (CPI) of manufacturing workers is becoming increasingly important as an appropriate indicator of general inflation, demonstrating the most accurate impact of price inflation on the cost of living for ordinary people.
Food, pan, supari, tobacco, fuel and lighting, housing, clothing, and miscellaneous expenses are all included in the CPI (Consumer Price Index) for industrial workers, with food receiving the most weight. This means that changes in food prices have a significant impact on the CPI.

Q.3. What are the required properties of the base period?
Ans:

The following characteristics should be present in the base period:

• The base year is a normal period, where extraordinary events occurred should not be used as base periods because they are unsuitable for general comparisons.
• Excessive values should not be used as the base period.
• The period should not be too far from the past because comparing it to the current period is impossible with such a base year because policies, economic, and social conditions change over time.
• The base period should be updated on a regular basis.

Q.4. What is the difference between a price index and a quantity index?
Ans:

The following is the difference between a price index and a quantity index:

• Price index numbers are used to measure and compare the prices of specific goods, whereas quantity index numbers are used to calculate the changes in the physical volume of production, construction, or employment.
• Price index numbers are more commonly used than quantity index numbers.
• Price indexes are unweighted index numbers, whereas quantity indexes are weighted index numbers.

Q.5. Why is it essential to have different CPI for different categories of consumers?
Ans:

In India, the Consumer Price Index (CPI) is calculated for various categories, as shown below.

• Industrial workers’ CPI.
• CPI for non-manual workers in cities.
• Agricultural labourers’ CPI

The calculation of three different CPIs is justified because the consumption patterns of the three groups (i.e., industrial workers, urban non-manual workers, and agricultural labourers) differ significantly. As a result, in order to assess the impact of price changes on the cost of living of the three groups, the index’s component items must be assigned different weights for each group. This necessitates the calculation of different CPIs for various consumer groups.

Summary

The index numbers are expressed as percentages. As a result, it is useful for comparison and simple to understand the differences between two points in time. Index numbers are better for framing economic and business policies. For example, consumer price index numbers can be used to calculate employee severance pay. Index numbers are classified into three types: value indexes, quantity indexes, and price indexes. A value index number is the ratio of the aggregate value of commodities in the current year to that of the base year. The quantity index measures changes in consumer goods. The price index is concerned with price changes.

FAQs on Uses and classification of index numbers

Students might be having many questions with respect to the Uses and Classification of Index Numbers. Here are a few commonly asked questions and answers.

Q.1. What is the meaning of index number classification?
Ans: Index numbers can be classified according to what they measure. The classifications in economics and business are as follows:

• Price
• Quantity
• Value
• Special purpose

Q.2. What is an index number? Give an example.
Ans: Index numbers quantify the net or relative change in a variable or set of variables. For example, if the price of an object rises from \({\rm{Rs}}.\,10\) in \(2007\) to \({\rm{Rs}}.\,15\) in \(2017\), the price index number will be \(150\), indicating a \(50\% \) increase in prices over this time period.

Q.3. What is the most commonly used index number?
Ans: A price index number is a normalised average (typically a weighted average) of price relatives for a specific class of services and/or goods in a specific region over a specific time period. It is the most common index number.

Q.4. What are the uses of index numbers?
Ans: The primary functions of an index number are to provide a helpful price to compare the magnitudes of the aggregates of related variables and to measure changes in these magnitudes over time. As a result, many different index numbers have been developed to address specific purposes.

Q.5. Who is the founder of the index number?
Ans: According to Kendall, M.G. \((1997)\), the true father of index numbers should be regarded as Lowe, Joseph.

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