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Question

Explain the concept and uses of index numbers.

Vidyadip · Accepted Answer

'Index numbers are devices for measuring differences in the magnitude of a group of related variables.- Croxton & Cowden
Index numbers are indispensable tools of economics and business analysis. Following are the main uses of index numbers:

Index numbers helps in formulating suitable economic policies and planning: Many of the economic and business policies are guided by index numbers. For example while deciding the increase of DA of the employees; the employer's have to depend primarily on the cost of living index. If salaries or wages are not increased according to the cost of living it leads to strikes, lock outs etc. The index numbers provide some guide lines that one can use in making decisions.
They are used in studying trends and tendencies: Since index numbers are most widely used for measuring changes over a period of time, the time series so formed enable us to study the general trend of the phenomenon under study. For example for last 8 to 10 years we can say that imports are showing upward tendency.
Useful to Business Community: Businessmen need to know the trends in the market to take decisions about wage rates, prices of the product, prices of raw materials etc. Therefore, index numbers are very useful for them.
Information Regarding Foreign Trade: Index of Exports and Imports provides relevant information regarding foreign trade and accordingly government can formulate its export-import policy, business men who are engaged in foreign trade can take their decisions and one can predict changes in inflow or outflow of foreign exchange.
They are useful in forecasting future economic activity: Index numbers are used not only in studying the past and present workings of our economy but also important in forecasting future economic activity. Index numbers measure the purchasing power of money.
The cost of living index numbers determine whether the real wages are rising or falling or remain constant: The real wages can be obtained by dividing the money wages by the corresponding price index and multiplied by 100. Real wages helps us in determining the purchasing power of money. Index numbers are used in deflating. Index numbers are highly useful in deflating i.e. they are used to adjust the wages for cost of living changes and thus transform nominal wages into real wages, nominal income to real income, nominal sales to real sales etc. through appropriate index numbers.
Used in Deflating: Deflating means correcting or adjusting a value which has inflated. It makes allowances for the effect of price changes. When prices rise, the purchasing power of money declines. If the money incomes of people remain constant between two periods and prices of commodities are doubled the purchasing power of money is reduced to half. For example if there is an increase in the price of rice from ₹ 10/ kg in the year 1980 to ₹ 20/kg in the year 1982. then a person can buy only half kilo of rice with ₹ 10. so the purchasing power of a rupee is only 50 paise in 1982 as compared to 1980.

Thus the purchasing power of money

$=\frac{1}{\text{ Price Index}}$

In times of rising prices the money wages should be deflated by the price index to get the figure of real wages. The real wages alone tells whether a wage earner is in better position or in worst position.

For calculating real wage, the money wages or income is divided by the corresponding price index and multiplied by 100.

$\text{i.e. Real wages}=\frac{\text{Money wages}}{\text{Price Index}}\times100$

$\text{Thus Real wages Index}=\frac{\text{Real wage of current year }}{\text{Real wage of base year}}\times100.$

Wages (₹)	100-110	110-120	120-130	130-140	140-150
No of Workers	4	12	20	7	5

Commodity	2008		2016
Commodity	Price	Quantity	Price	Quantity
A	10	30	12	35
B	9	10	11	15
C	8	20	7	25
D	6	20	7	25

Price (₹ per unit)	Maggi (Units)	Pasta (Units)
5	4	6
4	5	7
3	6	8
2	7	9
1	8	10

Price (₹)	Quantity Demanded by Isha (Units)	Quantity Demanded by Misha (Units)	Market Demand (Units)
10	3	-	8
9	-	8	15
8	11	-	22
7	-	14	30
6	20	22	-

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