Index numbers are devices for measuring the difference in the magnitude of a group of related variables. An index number of prices is that a number which indicates the price level of any given dete as compared with the level of prices at some standard dete called the base.
PREPARATION OF INDEX NUMBERS
The following are the various steps in the construction of an index number.
(i) Choice of the base year: The first step is to choose a year to serve as the base year i-e the year with reference to which the price changes n other years are expressed as percentages. Care must be excised in its selection. It should be an average year, neither a year of boom nor of depression.
(ii) Selection of Commodities: The second step is to select commodities the prices of which have to be taken to represent the general price level. The commodities should be really representative and should be sufficiently large in number. The selection of commodities also depends on the object with which the index is prepared.
(iii) Price Lists taken for each commodity: It is better to have an average of wholesale prices of the same commodity from a number of representatives markets. These prices are taken for the base year and also for the subsequent years the index number for which we want to construct. Retail prices are better because it is the retail prices which consumers actually pay. But retail prices are not taken because they differ widely from locality to locality.
(iv) Price of each commodity: The next step is to represent the price of each commodity for the base year as 100 and the price of the same commodity for the subsequent year as a percentage of the price for the base year. For instance of the price of wheat in the base year is Rs. 70 per quintal and is called 100 of Rs. 154 in the subsequent year should be called 220 and so on in the case of all the commodities taken and all the years.
(v) The Final step: The final step is t strike the average of the numbers thus obtained with reference to each year. The average for the base year will to course come to 100. The other average will be higher or lower than 100 according as the general price level has risen or fallen.
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