Statistics: Index Number

Conceptualization By: Soumen Roy, B.Com (H), AICWA.

Learning Objectives
Acquaintance with Key Terms Introduction to overall concept Solving of basic problems
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Key Terms - Slide I of III

Index Number Price Index
* Whole Price Index * Retail Price Index

Quantity Index Value Index Base Period Current Period

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Key Terms - Slide II of III

Simple Aggregate Index Number Simple Average Price Relative Index Weighted Aggregate Index Number
* Laspeyres Method * Paasches Method * Fishers Ideal Method * Bowleys Method * Marshall-Edgeworth Method * Kellys Method
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Key Terms - Slide III of III

Quantity / Volume Index Number Test of Consistency
* Unit Test * Time Reversal Test * Factor Reversal Test

Consumer Price Index Number

Conceptualization By Soumen Roy

Index Number
What is Index Number?.is a statistical
measure designed to show changes in variable or a group of related variables with respect to time, geographic location or other characteristic. - For example, if we want to compare the price level of 2009 with what it was in 2008, we shall have to consider a group of variables such as price of wheat, rice, vegetables, cloth, house rent etc., - We want one figure to indicate the changes of different commodities as a whole. This is called an Index number. - In general, index numbers are used to measure changes over time in magnitude which are not capable of direct measurement.
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Characteristics of Index Number

Index numbers are specified averages Index numbers are expressed in percentage Index numbers measure changes not capable of direct measurement. Index numbers are for comparison.
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Uses of Index Numbers

They measure the relative change. They are of better comparison. They are economic barometers. They compare the standard of living. They provide guidelines to policy. They measure the purchasing power of money.
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Types of Index Numbers

Price Index: Compares the prices for a group of commodities at
a certain time as at a place with prices of a base period. The wholesale price index reveals the changes into general price level of a country, but the retail price index reveals the changes in the retail price of commodities such as consumption of goods, bank deposits, etc.

Quantity Index: Is the changes in the volume of goods

produced or consumed. They are useful and helpful to study the output in an economy.

Value Index: Compare the total value of a certain period with

total value in the base period. Here total value is equal to the price of commodity multiplied by the quantity consumed.
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Notations
The following notations would be used through out the presentation: P1 = Price of current year P0 = Price of base year q1 = Quantity of current year q0 = Quantity of base year
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Problems in construction of Index Numbers

Purpose of the index numbers Selection of base period Selection of items Selection of source of data Collection of data Selection of average System of weighting
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Method of construction of Index Numbers:

Un Weighted
Simple Aggregate Index Numbers Simple Average of Price Relative
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Weighted
Weighted Aggregate Index Number Weighted Average of Price Relative
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Simple Aggregate Index Number

The price of the different commodities of the current year are added and the sum is divided by the sum of the prices of those commodities by 100. Symbolically: Simple aggregate price index = P01 = P1 / P0 * 100 Example 1:Calculate index numbers from the following data by simple aggregate method taking prices of 2000 as base.
Commodity A B C D Price Per Unit (In Rupees) Year: 2000 80 50 90 30 Year: 2004 95 60 100 45
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Simple Aggregate Index Number

Solution 1:
Commodity A B C D Total Price Per Unit (In Rupees) Year: 2000 (P0) 80 50 90 30 250 Year: 2004 (P1) 95 60 100 45 300

Simple aggregate price index = P01 = P1 / P0 * 100 = 300 / 250 * 100 = 120.
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Simple Average Price Relative Index

First calculate the price relative for the various commodities and then average of these relative is obtained by using arithmetic mean and geometric mean. Simple average of price relative by Arithmetic Mean: P01 = [ P1 / P0 *100] / n, where n is the number of commodities. Simple average of price relative by Geometric Mean: P01 = Antilog [ log (P1 / P0 *100)] / n

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Simple Average Price Relative Index

Example 2: From the following data, construct an index for 2004 taking 2000 as base by the average of price relative using (a) arithmetic mean and (b) Geometric mean.
Commodity A B C D Price in 2000 50 40 80 20 Price in 2004 70 60 100 30

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Simple Average Price Relative Index

Solution: (a) Price relative index number using Arithmetic Mean
Commodity A B C D Price in 2000 (P0) 50 40 80 20 Price in 2004 (P1) 70 60 100 30 Total P1 / P0 * 100 140 150 125 150 565

Simple average of price relative index = (P01) = [ P1 / P0 *100] / n = 565 / 4 = 141.25

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Simple Average Price Relative Index

Solution: (b) Price relative index number using Geometric Mean
Commodi ty A B C D Price in 2000 (P0) 50 40 80 20 Price in 2004 (P1) 70 60 100 30 P1 / P0 * 100 140 150 125 150 Total log(P1/P0 *100) 2.1461 2.1761 2.0969 2.1761 8.5952

Simple average of price relative index = (P01) = Antilog [ log (P1 / P0 *100)] / n = Antilog 8.5952 / 4 = Antilog [2.1488] = 140.9
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Weighted Aggregate Index Numbers

In order to attribute appropriate importance to each of the items used in an aggregate index number some reasonable weights must be used. There are various methods of assigning weights and consequently a large number of formulae for constructing index numbers have been devised of which some of the most important ones are: 1. Laspeyre s method 2. Paasche s method 3. Fisher s ideal Method 4. Bowley s Method 5. Marshall- Edgeworth method 6. Kelly s Method
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Weighted Aggregate Index Numbers

Laspeyre s method: The Laspeyres price index is a weighted aggregate price index, where the weights are determined by quantities in the base period and is given by: P01 L = [P1q0 / P0q0 ] *100 Paasche s method: The Paasche s price index is a weighted aggregate price index in which the weight are determined by the quantities in the current year. This is given by: P01 P = [P1q1 / P0q1 ] *100 Fisher s ideal Method: Fisher s Price index number is the geometric mean of the Laspeyres and Paasche indices Symbolically: P01 F = [ P01L * P01P]

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Weighted Aggregate Index Numbers

Fisher s ideal Method: It is known as ideal index number because: (a) It is based on the geometric mean. (b) It is based on the current year as well as the base year. (c) It conform certain tests of consistency. (d) It is free from bias. Bowley s Method: Bowley s price index number is the arithmetic mean of Laspeyre s and Paasche s method. Symbolically: P01 B = [P01L + P01P] / 2 Marshall- Edgeworth method: This method also both the current year as well as base year prices and quantities are considered. Symbolically: P01 ME = [ (q0 + q1) p1 / (q0 + q1) p0] * 100
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Weighted Aggregate Index Numbers

Kellys Method: The following formula is suggested for constructing the index number. Symbolically: P01 K = [P1q / P0q ] *100 , where q = (q0 + q1) / 2 Here the average of the quantities of two years is used as weights. Example 3: Construct price index number from the following data by applying (i) Laspeyres, (ii) Paasches and (iii) Fishers Ideal Method.
Commodity Price A B C D 2 5 4 2 2000 Qty. 8 12 15 18 Price 4 6 5 4 2001 Qty 5 10 12 20
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Weighted Aggregate Index Numbers

Solution 3:
Commodity A B C D p0 q0 2 5 4 2 8 12 15 18 p1 4 6 5 4 q1 5 10 12 20 p0q0 16 60 60 36 172 p0q1 10 50 48 40 148 p1q0 32 72 75 72 251 p1q1 20 60 60 80 220

(i) Laspeyre s Price Index = P01 L = [P1q0 / P0q0 ] *100 = 251 / 172 * 100 = 145.93

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Weighted Aggregate Index Numbers

(ii) Paasche s Price Index = P01 P = [P1q1 / P0q1 ] *100 = 220 / 148 * 100 = 148.64 (iii) Fishers Ideal Index = P01 F = [ P01L * P01P] = [145.93 * 148.64] = 21692.49 = 147.28 Interpretation: The results can be interpreted as follows: If 100 rupees were used in the base year to buy the given commodities, we have to use Rs 145.93 in the current year to buy the same amount of the commodities as per the Laspeyre s formula. Other values give similar meaning.
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Weighted Aggregate Index Numbers

Example 4: Calculate a suitable price index from the following data
Commodity A B C 20 15 8 Quantity 2006 2 5 3 Price 2007 4 6 2

Solution 4: Here the as quantities are given in common we can use Kelly s index price number.

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Weighted Aggregate Index Numbers

Commodity Q A B C 20 15 8 p0 2 5 3 p1 4 6 2 Total p0q 40 75 24 139 p1q 80 90 16 186

Now, P01 K = [P1q / P0q ] *100 , where q = (q0 + q1) / 2 i.e., P01 K = 186/139*100 = 133.81

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Weighted Average of Price Relative Index

When the specific weights are given for each commodity, the weighted index number is calculated by the formula: pw / w, where W= Weight of the commodity P = the price relative index = (P1 / P0 * 100). Note: When the base year value P0q0 is taken as weight, i.e., W= P0q0, then the above becomes Laspeyres formula. When the weights are taken as W=P0q1, then the above becomes Paasches formula

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Weighted Average of Price Relative Index

Example 5: Compute the Weighted Average index number for the following data :
Commodity Price Current Year A B C 5 3 2 Base Year 4 2 1 60 50 30 Weight

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Weighted Average of Price Relative Index

Solution 5:
Commodity A B C P1 5 3 2 P0 4 2 1 W 60 50 30 140 P=P1 / P0 * 100 125 150 200 PW 7500 7500 6000 21000

Weighted Average of Price Relative Index = pw / w = 21000 / 140 = 150

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Quantity / Volume Index Number

The quantity index numbers measure the physical volume of production, employment and etc. The most common type of the quantity index is that of : Laspeyre s quantity index number = Q01 L = q1p0 / q0p0 *100 Paasches quantity index number = Q01 P = q1p1 / q0p1 * 100 Fishers quantity index number = Q01 F = [ Q01 L * Q01 P ] These formulae represent the quantity index in which quantities of the different commodities are weighted by their prices.

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Quantity / Volume Index Number

Example 6: From the following data compute quantity indices by (i) Laspeyre s method, (ii) Paasche s method and (iii) Fisher s method.
2000 Commodity A B C Price 10 12 15 Total Value 100 240 225 Price 12 15 17 2002 Total Value 180 450 340

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Quantity / Volume Index Number

Solution 6: Here instead of quantity, total values are given. Hence first we find the quantities of base year and current year, i.e., Quantity = Total Value / Price.
Com. A B C P0 10 12 15 q0 10 20 15 P1 12 15 17 q1 15 30 20 P0q0 100 240 225 565 P0q1 150 360 300 810 P1q0 120 300 255 675 P1q1 180 450 340 970

(i) Laspeyre s quantity index number = Q01 L = q1p0 / q0p0 *100 = 810 / 565 *100 = 143.36
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Quantity / Volume Index Number

(ii) Paasches quantity index number = Q01 P = q1p1 / q0p1 * 100 = 970 / 675 *100 = 143.70. (iii) Fishers quantity index number = Q01 F = [ Q01 L * Q01 P ] = [ 143.36 * 143.70] = 143.53.

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Test of Consistency of Index Numbers

Several formulae have been studied for the construction of index number. The question arises as to which formula is appropriate to a given problems. A number of tests been developed and the important among these are: (1) Unit test: . requires that the formula for constructing an index should be independent of the units in which prices and quantities are quoted. Except for the simple aggregate index (unweighted) , all other formulae discussed here satisfy this test. (2) Time Reversal test: .the formula for calculating the index number should be such that it gives the same ratio between one point of comparison and the other, no matter which of the two is taken as base.
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Test of Consistency of Index Numbers

Symbolically, the following relation should be satisfied.: P01 * P10 = 1, Where P01 is the index for time 1 as time 0 as base and P10 is the index for time 0 as time 1 as base. If the product is not unity, there is said to be a time bias is the method. Fisher s ideal index satisfies the time reversal test. Proof: P01 F = [ P1q0 / P0q0 * P1q1 / P0q1] P10 F = [ P0q1 / P1q1 * P0q0 / P1q0] Then P01 F * P10 F = [ P1q0 / P0q0 * P1q1 / P0q1* P0q1 / P1q1 * P0q0 / P1q0] = 1=1 Therefore Fisher ideal index satisfies the time reversal test.
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Test of Consistency of Index Numbers

(3) Factor Reversal test: .holds that the product of a price index and the quantity index should be equal to the corresponding value index. In other word, if P01 represent the changes in price in the current year and Q01 represent the changes in quantity in the current year, then P01 *q01 = P1q1 / P0q0. Fisher s ideal index satisfies the factor reversal test. Proof: P01 F= [P1q0 / P0q0 * P1q1 / P0q1] Q01F = [q1P0 / q0P0 * q1P1 / q0P1] Then P01 F * q01F = [P1q0 / P0q0 * P1q1 / P0q01* q1P0 / q0P0 * q1P1 / q0P1] = [P1q1 / P0q0 ] = P1q1 / P0q0 Therefore Fisher ideal index satisfies the time reversal test.
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Test of Consistency of Index Numbers

Example 7: Construct Fisher s ideal index for the following data. Test whether it satisfies time reversal test and factor reversal test.
Commodity A B C 12 15 5 Base Year Quantity Price 10 7 5 Quantity 15 20 8 Current Year Price 12 5 9

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Test of Consistency of Index Numbers

Solution 7:
Com A B C q0 12 15 5 P0 10 7 5 q1 15 20 8 P1 12 5 9 P0q0 120 105 25 250 P0q1 150 140 40 330 P1q0 144 75 45 264 P1q1 180 100 72 352

Fishers Ideal Index = P01F = [P1q0 / P0q0 * P1q1 / P0q1] *100 = [ 264 / 250 * 352 / 330] * 100 = 1.056 * 1.067] *100 = 106.12
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Test of Consistency of Index Numbers

Time Reversal Test: This is satisfied when P01 * P10 = 1. Now, P01 F = [P1q0 / P0q0 * P1q1 / P0q1] = [264 / 250 * 352 / 330] And P101 F = [ P0q1 / P1q1 * P0q0 / P1q0] = [330 / 352 * 250 / 264] Then, P01 F * q01F = [264 / 250 * 352 / 330 * 330 / 352 * 250 / 264] = 1 = 1. Hence Fisher ideal index satisfy the time reversal test.

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Test of Consistency of Index Numbers

Factor Reversal Test: This is satisfied when P01 *q01 = P1q1 / P0q0. Now, P01 F= [P1q0 / P0q0 * P1q1 / P0q1] = [264 / 250 * 352 / 330] And Q01F = [q1P0 / q0P0 * q1P1 / q0P1] = [330 / 250 * 352 / 264] Then, P01 *q01 = [264 / 250 * 352 / 330 * 330 / 250 * 352 / 264] = [ (352 / 250) ] = 352 / 250 = P1q1 / P0q0 Hence Fisher ideal index number satisfy the factor reversal test.

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Consumer Price Index

Also called the cost of living index. It represent the average change over time in the prices paid by the ultimate consumer of a specified basket of goods and services. A change in the price level affects the costs of living of different classes of people differently. The scope of consumer price is necessary, to specify the population group covered. For example, working class, poor class, middle class, richer class, etc and the geographical areas must be covered as urban, rural, town, city etc.
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Use of Consumer Price Index

Very useful in wage negotiations, wage contracts and dearness allowance adjustment in many countries. At government level, the index numbers are used for wage policy, price policy, rent control, taxation and general economic policies. Change in the purchasing power of money and real can be measured. Index numbers are also used for analyzing market price for particular kinds of goods and services.

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Method of Constructing Consumer Price Index

Methods of Construction of CPI
Aggregate Expenditure Method / Aggregate Method Family Budget Method / Method of Weighted Relative
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Method of Constructing Consumer Price Index

Aggregate Expenditure method: This method is based upon the Laspeyre s method. It is widely used. The quantities of commodities consumed by a particular group in the base year are the weight. The formula is Consumer Price Index number = P1q0 / P0q0 Family Budget method or Method of Weighted Relatives: This method is estimated aggregate expenditure of an average family on various items and it is weighted. The formula is Consumer Price index number = Pw / w, Where P = (P1 / P0 * 100) for each item. w = value weight i.e., P0q0. Note: Weighted average price relative method which we have studied before and Family Budget method are the same for finding out consumer price index.
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Consumer Price Index

Example 8: From the following calculate the cost of living index using Family Budget Method taking 2000 s base year.
Items Food Rent Clothing Fuel & Lighting Miscellaneous Weights 35 20 10 15 20 Price in 2000 (Rs) 150 75 25 50 60 Price in 2004 (Rs) 140 90 30 60 80

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Consumer Price Index

Solution (8):
Items Food Rent Clothing Fuel & Lighting Miscellaneous W 35 20 10 15 20 100 P0 P1 P = P1/P0 *100 PW 3266.55 2400.00 1200.00 1800.00 2666.60 11333.15 150 140 93.33 75 25 50 60 90 30 60 80 120.00 120.00 120.00 133.33

Consumer price index by Family Budget method = Pw / w = 11333.15 / 100 = 113.33.

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Acknowledgements

Various sources from internet free from IPR restriction.

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