Maharashtra Board Class 12 Economics Chapter 6 Index Numbers PDF Download

Index Numbers

Introduction

Index numbers are one of the most used statistical tools in economics. An index number is a device to measure changes in an economic variable (or group of variables) over a period of time. Index numbers were originally developed to measure changes in the price level. In the present context, it is also used to measure trends in a wide variety of areas that includes stock market prices, cost of living, industrial and agricultural production, changes in exports and imports etc. Index numbers are not directly measurable, but represent relative changes.

Origin of Index Numbers

During the 17th century, Rice Vaughan, an Englishman and eminent writer was concerned with the rise in prices which had occurred in his native land over the preceding century. The first study using Index Numbers was done in the early 18th century. In 1707, William Fleetwood made a comparison of the prices of certain commodities such as wheat, oats, beans, cloth, meat etc. for the periods 1440-1460 and 1686-1706. The results of this study are presented in his work, 'Chronicon Preciosum' (1707). In 1738, Charles de Ferrare Dutot of France constructed a simple aggregative index for two periods 1508 and 1735 and compared the costs for an identical list of commodities. However, the first recorded index number appeared in the work of G.R. Carli, an Italian who used a modified form of the simple average of price relatives in 1764.

Definitions of Index Numbers

1) Spiegel : "An index number is a statistical measure designed to show changes in a variable or a group of related variables with reference to time, geographical location and other characteristics such as income, profession etc."

2) Croxton and Cowden : "Index Numbers are devices for measuring differences in the magnitude of a group of related variables."

Teacher's Note

Index numbers help us understand if prices are going up or down. Just like we track our school marks over the year to see if we are improving, index numbers track prices in India to see if things are getting more expensive.

Exam Trick

Remember: Index number of 100 = base year. If current year is 150, prices went up by 50%. Think of it like: 100 = starting point, 150 = 50% higher than starting point.

Points to Remember

Index numbers measure changes in price, quantity, or value over time.
Base year has index = 100 always.
Current year index shows how much it changed from the base year.
Index numbers are used to measure inflation and cost of living.
They help the government make better policies.

Features of Index Numbers

1) Index numbers are statistical devices.

2) Index numbers are specialized averages which are capable of being expressed in percentages.

3) Index numbers measure the net change in one or more related variables over a period of time or between two different time periods or two different localities.

4) Index number which is computed from a single variable is called a 'univariate index', whereas an index which is constructed from a group of variables is called a 'composite index'.

5) The year for which the index number is prepared is the current year.

6) The year with which the changes are measured is called the base year.

7) The base year's index is assumed as 100 and accordingly the value of the current year is calculated.

8) Index numbers are also referred to as 'barometers of economic activity', since it is used to measure the trends and changes in the economy.

Teacher's Note

Base year is like the reference point in your report card. If 2020 is the base year, we compare all other years with 2020. In India, we use different base years for different indices.

Exam Trick

Remember: Base year suffix is 'o' (old), Current year suffix is '1' (one comes after zero). So p0 = old price, p1 = new price.

Points to Remember

Base year is the year we compare with - it always equals 100.
Current year is the year we are measuring - its value changes.
p0, q0 = base year price and quantity.
p1, q1 = current year price and quantity.
Index numbers show percentage change from the base year.

Terminologies Used in Index Numbers

Base Year : The year with respect to which comparisons are made is the base year. It is denoted by the suffix 'o'.

Current Year : The year for which comparisons are required to be made is the current period. It is denoted by the suffix '1'.

Notations

\(p_0\) = Price of the commodity in the base year

\(p_1\) = Price of the commodity in the current year

\(q_0\) = Quantity of the commodity consumed or purchased in the base year

\(q_1\) = Quantity of the commodity consumed or purchased in the current year

Types of Index Numbers

1) Price Index Number : It measures the general changes in the prices of goods. It compares the level of prices between two different time periods.

2) Quantity Index Number : It is also called volume index number. It measures changes in the level of output or physical volume of production in the economy. For example, changes in agricultural production, industrial production etc. over a period of time.

3) Value Index Number : The value of a commodity is the product of its price and quantity (p × q). Value index number measures the changes in the value of a variable in terms of rupee. It is a more informative index as it combines both, changes in the price as well as quantity.

4) Special Purpose Index Number : They are constructed with some specific purpose. For example, import-export index numbers, labour productivity index numbers, share price index numbers etc.

Some Widely Used Index Numbers by the Government of India

Consumer Price Index

Wholesale Price Index

Index of Agricultural Production

Index of Industrial Production

Index of Service Production

Index of Export/Import

Human Development Index

Teacher's Note

There are four main types of index numbers. Price Index tells us if things got expensive. Quantity Index shows if we made more or less goods. Like when we check vegetable prices at the market versus factory production numbers.

Exam Trick

Remember the four types: Price (money), Quantity (amount), Value (price × quantity), Special Purpose (other uses). Price Index = simple, Value Index = has both price and quantity information.

Points to Remember

Price Index Number measures change in prices only.
Quantity Index Number measures change in production or quantity only.
Value Index Number combines both price and quantity changes.
Special Purpose Index Numbers are made for specific needs.
Value Index is most useful because it shows the complete picture.

Significance of Index Numbers in Economics

Index numbers are indispensable tools of economic analysis. Following points explain the significance of index numbers :

1) Framing Suitable Policies : Index numbers provide guidelines to policy makers in framing suitable economic policies such as agricultural policy, industrial policy, fixation of wages and dearness allowances in accordance with the cost of living etc.

2) Studies Trends and Tendencies : Index numbers are widely used to measure changes in economic variables such as production, prices, exports, imports etc. over a period of time. For example, by examining the index of industrial production for the last five years, we can draw important conclusions about the trend of industrial production whether it shows an upward tendency or a downward tendency.

3) Forecasting About Future Economic Activity : Index numbers are useful for making predictions for the future based on the analysis of the past and present trends in the economic activities. For example, based on the available data pertaining to imports and exports, future predictions can be made. Thus, forecasting guides in proper decision making.

4) Measurement of Inflation : Index numbers are also used to measure changes in the price level from time to time. It enables the government to undertake appropriate anti-inflationary measures. There is a legal provision to pay the D.A. (dearness allowance) to the employees in organised sector on the basis of changes in Dearness Index.

5) Useful to Present Financial Data in Real Terms : Deflating means to make adjustments in the original data. Index numbers are used to adjust price changes, wage changes etc. Thus, deflating helps to present financial data in real terms (at constant prices).

Teacher's Note

Index numbers help the government make good decisions. When prices go up too much, the government uses index numbers to give workers more salary through DA. It is like giving a student extra marks when the test becomes harder.

Exam Trick

Remember five uses: 1) Policy making 2) Study trends 3) Forecast future 4) Measure inflation 5) Real data. DA is paid based on Dearness Index - when prices go up, workers get more money.

Points to Remember

Index numbers help make government policies for farming and industry.
They show if economy is growing or shrinking over time.
They help predict future economic changes.
They measure inflation and rising cost of living.
They help adjust salaries fairly when prices go up.

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