DefinitionAn index number is a statistical device designed to compare a group of related variables over a period of time or space.
It is a ratio or an average of ratios expressed as a percentage. Generally two time periods are involved while calculating index numbers, one of which is the base time period that serves as the standard point or the reference point for comparison.
Generally index numbers are of three types:
- Price index numbers: These are index numbers that indicate the general level of prices of articles in the current period as compared to that of the base period.
- Quantity index numbers: These are index numbers of quantity of goods manufactured by a firm, quantity of goods imported or exported, quantity of agricultural products, etc.
- Value index numbers: These are index numbers of total money value of transactions taking place.
Use of Index Numbers
- They are used as a barometer to measure economic activities
- They are useful in formulating suitable policies, knowing the trends, adjusting the original data or price changes, etc.
- They are useful for knowing the purchasing power of money
- They are useful in comparing variations in production, price, demand, supply, etc.
- Cost of living index measures changes in the cost of living over a given period
Limitations of Index Numbers
- Index numbers are affected by sampling errors or formula errors
- Many formulae are used for the construction of index numbers. Different formulae give different values for the index
- It indicates only the general trend, not the actual trend
- The quality of the product is not taken into account