Index Numbers — Economics STD 11 Commerce — Question

Although index numbers are indispensable tools in economics, business, management etc, they have their limitations and proper care should be taken while interpreting them. Some of the limitations of index numbers are as given below:

1. Not based on all items: Since index numbers are generally based on a sample, it is not possible to take into account each and every item in the construction of index.
2. Not free from Error: At each stage of the construction of index numbers, starting from selection of commodities to the choice of formulae there is a chance of the error being introduced. Index numbers are also special type of averages, since the various averages like mean, median, GEOMETRIC MEAN have their relative limitations, their use may also introduce some error. None of the formulae for the construction of index numbers is exact and contains the so called formula error. For example Laspayer's index number has an upward bias while Paasche's index has a downward bias.
3. Meant for Particular Purpose: An index number is used to measure the change for a particular purpose only. Its misuse for other purpose would lead to unreliable conclusions.
4. Difference of Time: With the passage of time, it is difficult to make comparisons of index numbers. Over time a person's habit, taste etc. Also undergo change. Consequently, index numbers constructed on the basis of old consumption pattern and hence it becomes obsolete over time. In the construction of price or quantity index numbers it may not be possible to retain the uniform quality of commodities during the period of investigation.
5. Difficulty in getting data on retail prices: Retail prices vary a great deal from place to place. Most of the index numbers are prepared on the basis of whole sale prices.
6. International Comparison is not Possible: Different countries develop their indices different years as base years and hence inter-country comparison is not possible by using international comparison.