Index number is a measure to record changes in 1 or 2 variables(current and base year quantities) over a period of time.
Uses of Index numbers:
1.To measure changes in the value of money.
2.To measure the cost of living.
3.Helps to formulate economic policies.
Limitations of Index numbers:
1.Index numbers are mere indications of relative changes.
2.The purpose of using a formula can be different in many situations, which leads to a confusion.
3.One of the major drawbacks is that each average is specialised and can be used only in certain cases considering the limitations of the average.
Types of Index numbers:
1.Price index number:It measures the relative changes in the price of a commodity between two periods.
2.Quantity index number:It measures the relative changes in the quantity of a commodity consumed between two periods.
3.Value index number:Measures the change in a nominal value relative to its value in the base year.
Methods of calculating the index number:
1.Simple
-Simple Aggregate method : A
-Simple Average of price relatives : B
2.Weighted
-Weighted Aggregate method : C
-Weighted average pf price relatives : D
Before we get into the formulae, let's know a few abbreviations:
P01; here P is the price relative, 0 is the base year and 1 is the current year.
N is the number of observations.
Just to add on to the detail;
v01 = Σp1q1/Σp0q0
Tests of consistency;
1.TRT-Time reversal test
P01 * P10 = 1
TRT is not satisfied by Laspeyre's price index and Paache's price index, but it's satisfied by Fisher's price index.
2.FRT-Factor reversal test
P01 * Q01 = V01
FRT is satisfied only by Fisher's price index.
We can notice that Fisher's price index satisfies both time reversal and factor reversal test. This is one of the reason why Fisher's price index is known as the ideal index number. The other reason is that this index considers both the current and base year quantities.
Consumer Price Index is also known as the cost of living index.
It represents the average change in price over a period of time, paid by a consumer for a fixed basket of goods and services.
Uses of CPI:
1.It indicates the changes in the consumer prices.
2.It evaluates the purchasing power of money.
3.It is also used for comparison purposes.
When we talk about the limitations of CPI;
1. CPI focuses on a fixed basket, as consumer behaviour cannot be predicted, we can't be very sure about CPI value to be relevant.
2. Quality is not considered while calculating the CPI.
3. Inflation effects are not taken into consideration as the basket is fixed.
CPI can be computed using 2 methods:
1.Aggregate Expenditure method
CPI = (Total expenditure in current year/Total expenditure in base year)*100;
which means;
CPI = Σp1q0/Σp0q0 * 100
2.Family Budget method
CPI = ΣWP/ ΣW
where P = p1/p0 * 100
Uses of Index numbers:
1.To measure changes in the value of money.
2.To measure the cost of living.
3.Helps to formulate economic policies.
Limitations of Index numbers:
1.Index numbers are mere indications of relative changes.
2.The purpose of using a formula can be different in many situations, which leads to a confusion.
3.One of the major drawbacks is that each average is specialised and can be used only in certain cases considering the limitations of the average.
Types of Index numbers:
1.Price index number:It measures the relative changes in the price of a commodity between two periods.
2.Quantity index number:It measures the relative changes in the quantity of a commodity consumed between two periods.
3.Value index number:Measures the change in a nominal value relative to its value in the base year.Methods of calculating the index number:
-Simple Aggregate method : A
-Simple Average of price relatives : B
2.Weighted
-Weighted Aggregate method : C
-Weighted average pf price relatives : D
Before we get into the formulae, let's know a few abbreviations:
P01; here P is the price relative, 0 is the base year and 1 is the current year.
N is the number of observations.
Just to add on to the detail;
v01 = Σp1q1/Σp0q0
Tests of consistency;
1.TRT-Time reversal test
P01 * P10 = 1
TRT is not satisfied by Laspeyre's price index and Paache's price index, but it's satisfied by Fisher's price index.
2.FRT-Factor reversal test
P01 * Q01 = V01
FRT is satisfied only by Fisher's price index.
We can notice that Fisher's price index satisfies both time reversal and factor reversal test. This is one of the reason why Fisher's price index is known as the ideal index number. The other reason is that this index considers both the current and base year quantities.
Consumer Price Index is also known as the cost of living index.
It represents the average change in price over a period of time, paid by a consumer for a fixed basket of goods and services.
Uses of CPI:
1.It indicates the changes in the consumer prices.
2.It evaluates the purchasing power of money.
3.It is also used for comparison purposes.
When we talk about the limitations of CPI;
1. CPI focuses on a fixed basket, as consumer behaviour cannot be predicted, we can't be very sure about CPI value to be relevant.
2. Quality is not considered while calculating the CPI.
3. Inflation effects are not taken into consideration as the basket is fixed.
1.Aggregate Expenditure method
CPI = (Total expenditure in current year/Total expenditure in base year)*100;
which means;
CPI = Σp1q0/Σp0q0 * 100
2.Family Budget method
CPI = ΣWP/ ΣW
where P = p1/p0 * 100
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