Definition: Index Number is a statistical tool that gauges the changes in the degree of a variable or group of related variables over a specified period of time, or over two different situations.
Index numbers are applicable to the values of economic time series. It reflects the general relative change that is primarily used by economists to present economic data time series and simplify comparison between variables over time.
Characteristics of Index Number
- Specialized average: Index Number is a specialized average that facilitates measurement of relative change in the level of a particular variable over time.
- Expressed in percentage: It is expressed in percentage terms to indicate the magnitude of relative change.
- Measurement of Relative Change: It measures the relative change in the value of a certain phenomenon or a group thereof from time to time such as price, quantity, or value, in comparison to the base period. For example: Suppose the change in the price of a commodity in the year 2020 is measured in comparison to the year 2010, then in such a case the base period is 2010, whereas the year 2020 is the current year.
- Measures the effect of those factors whose direct measurement is difficult: It measures the changes in the variables, whose direct measurement is not possible. For example Cost of living or economic activity in a nation cannot be measured directly, however, one can evaluate relative changes in these activities by measuring changes in the values of factors that influence them.
What is Base Period?
When you have two given periods, the period with which a comparison is made, is the base period.
An index number begins in a specific year called the base year or reference year, whose value is 100. And in the following years, the percentage increases tend to shift the index number above or below its base value, i.e. 100. This means that, if the index number for a year is 105, it reflects a 5% rise from the base year, whereas when the index number is 95, it signifies a 5% fall from its base year value.
Classification of Index Number
1. Price Indices
It is a universally used index number, that measures the change in prices a good or certain good over a period of time, and makes the comparison in the difference in their prices from one geographical location to another.
For Example, You might have been aware of the consumer price index that gauges the change in prices of consumer goods and services, at the retail level and the wholesale price index which measures the change in prices of goods and services, at the wholesale level.
Note: The price of certain items may be rising while the prices of other items are falling. The price index will only show the average variation in the price of a group of related commodities.
2. Quantity Indices
As the name suggests, it measures the change in the physical volume of commodity or group of commodities over a period of time in an economy, i.e. quantity of output produced, distributed, and consumed. In this way, it facilitates the study of the level of physical output.
For Example: To analyze the production of pulses in the country over a period of time, to measure the imports and exports, of a country, etc
3. Value Indices
Value indices measure the total effect of the change in price and quantity, i.e. total value of production, of a commodity or group of commodities over a period of time.
For Example: To measure the cost of living in a particular city for a particular group of people.
Types of Index Numbers
- Simple Index Number: Index Number which is used by economists to measure the relative change in a single variable, it is termed as Simple Index. For example Hourly wages in manufacturing.
- Composite Index Number: Index Number which is used to measure changes in the value of several variables like price, the volume of production, cost of living, number of road accidents, etc., is termed as a composite index.
A Word from Business Jargons
An index number is like a barometer that gauges the change in the level of variable or group of variables. It helps in determining the change in the values of variables, in percentage terms, over a period of time.