Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

INDEX NUMBERS
Index Numbers are "specialized averages" which study the changes in prices of different
commodities and represent the same in a single figure. They are "expressed in
percentages" or reduced to a common denominator, with reference to some base year,
ignoring % sign. They "measure changes" in the economic activities, and cost of living.
They give a "comparative picture" of two periods relating to changes. They make the
complicated data converted into a "simplified data". They exhibit the relative rather
than absolute aspect of any phenomenon which is stretched over a period of time.
Meaning of Index Numbers
"An Index Number is a number which indicates the level of a certain phenomenon at any given
date in comparison with the level of the same phenomenon at some standard date.”
"An Index Number is a single ratio (usually in percentages) which measures the combined (i.e.
averaged) change of several variables between the two different times, places or situations."
“An Index Number is a quantity which, by reference to a base period, shows its variations or
changes in the magnitude over a period of time."
Purposes of Index Numbers
Following are the different purposes for which the index numbers are computed:
 To measure and compare changes in a variable or a set of variables with some base
year.
 To measure the purchasing power of money which is of great help in finding out
the real wages or incomes of the people.
 To provide guidelines to policy making in business field.
Importance of Index Numbers
1. Index numbers are called "Economic Barometers" as they indicate the pulses of
economy and tendencies in price fluctuations.
2. They measure the pressure of economic activities of the country.
3. They are helpful in studying the trends or tendencies in the level of any
phenomenon
4. They are useful in formulating the business policies and forecasting the future
events.
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

5. They provide a good basis for comparison as they are expressed in abstract units
(short figures) of measurement.
6. Index numbers are not only useful in the field of business but also they are useful
in the field of agriculture, employment' and governance.
7. They reduce the complex form of measurement to the simple numbers.
8. They provide a useful method of combining units of dissimilar nature into 'one
meaningful value.
9. They measure the purchasing power of money and help in finding out the real
wages or incomes of the people.
Importance of index numbers is increasing day by day as they are used constantly by
the government departments, business men, economists, professional men,
contractors, engineers and industrialists. Today, they are one of the most widely used
important statistical devices.
Limitations of Index Nuumbers
In spite of the importance of Index Numbers, they suffer from a number of limitations
as under:
i. Biased /Sampling: In the process of biased sampling an error is systematically
incorporated. This makes the index numbers reflect the economic activities in a
wrong way.
ii. Passage of Time: The period between the base year and the current year is not having
the constant standard of living. Changes do take place in fashion, efficiency,
attitude, behaviour and technology. These changes are not taken into
consideration as they are influencing the changes in economic activities.
iii. Common Index Number: We cannot compute a single or standard index number
common to all the economic activities. For each phenomenon under study, we
have to construct a special index number.
iv. Common Method: There is no common method for computing the index numbers
for different activities. The methods of computation varies according the nature of
data available.
v. Change in the Items: The items selected in the base year may not be in continuous
use and there may appear substitutes. Even then if the commodities remain the
same in current year, their qualities might have been changed drastically.
vi. Base Year: It is a problem to select the correct base year. There is no suitable or
normal or ideal year to be considered as the base year. There will be different index
numbers for different base years for the same current year.
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

TYPES OF INDEX NUMBERS

1. Wholesale Price Index Numbers: The Wholesale Price Index Numbers reflect the
changes in the general price level of a country. They cover a number of
commodities and markets, and intended to measure wholesale prices of specific
commodities. They are designed to show price changes for the commodities sold
at a particular place in a particular year with reference to a base year. They are often
used in the periodic adjustment of long-term purchases or rental agreements as
they serve as an indicator of general economic change.
2. Retail Price Index Numbers: These Numbers reflect the changes in the retail prices of
various commodities, such as consumption goods, stocks, shares, deposits, bonds
and other goods of daily use by a common man. They are popularly known as the
"Cost of Living Index Numbers" or "Consumer Price Index Numbers". They enable us to
study the effect of changes in the retail prices over a period of time. The prices
relate to a basket of goods or commodities on the purchasing power or cost of
living of a class of people. The consumer price index numbers are widely used as
escalators for adjustment of wages of workers and employees. They give an exact
idea of the effect of the change in retail prices on the cost of living of various classes
of people.
3. Quantity Index Numbers: The Quantity Index Numbers study the changes in the
volume of goods produced, distributed and consumed. They cover both the
industrial and agricultural goods and take into account the imports and exports
also. They measure the level of physical output of a country for a period of time.
4. Value Index Number: -The Value Index Numbers study the changes in the total value
(price x quantity) of the commodities concerned for a period of time. However, these
indices are not in common use like other indices.
5. Specific Purpose Index Numbers: There are various index numbers that measure the
changes in different phenomena such as profits, sales, production, expenditure
and other business activities to serve the specific purpose. They are of great help
for the business community in forecasting the future events. The purpose of
constructing these index numbers is specific and they are not regularly used. They
are used for forming business policies by private organizations.
Steps in Constructing Index Numbers
The technique of constructing index numbers involves a number of steps which are
to be observed. These steps are,
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

1. Objectives: The first and the foremost step is to determine clearly the objectives for
which the index numbers are required. The purpose of constructing the index
numbers must be specifically mentioned well in advance.
2. Choice of Base Year: The choice of the base year or reference year is very important
in constructing the index numbers. The "Base year" is a year with which index
numbers are to be compared or to which they are to be referred. It should be a
period which is having normal or stable economic activities & should not be
characterized by abnormal economic activities. The year selected as the base year
shall not be too far from the current year under study.
Base year methods
There are two methods of base year, i.e. Fixed Base Method and Chain Base Method.
 "Fixed Base Method" refers to the base year, which is common to all the prices that
are changing. The fixed base year serves as a common standard of comparison. It
remains unchanged for the calculations during the period of index number. For
price indices and cost of living indices, the fixed base year will-be appropriate for
calculations.
 Chain Base Method" refers to the base year which goes on shifting from one period
to another. The base year is not fixed. Generally, the previous year will be the base
year for the calculation of index number for the current year.
Thus the base year is some specific year or period of time with reference to which the
current year changes are based. The base year represents the value 100 and the current
year changes are based on it.
3. Selection of Items: The items or commodities selected should be relevant to the
purpose of the index number. In computing cost of living index numbers, select
only those items which are consumed by the consumers & in calculating wholesale
price index numbers, consider only those items which enter into the wholesale
market. However, the number of items selected should neither be too small or too
large. Only standardized and related items should be selected.
4. Price Quotation: The prices referred to for constructing the index numbers should
be relevant to the purpose and period under study. The prices quoted may be
relating to any time-opening, closing, average of day, average of week and other
periods. While obtaining the price quotations, the reliability of sources are viewed
properly.
5. Choice of Average: The index numbers are calculated by using the number of
averages. The arithmetic average is the most appropriate average for calculating the
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

index numbers. However, the geometric mean possesses some of the important
characteristics superior to that of the arithmetic mean.
6. System of Weight: The items collected for computing the index numbers are always
not of equal importance. To bring all the items in equal importance, weights are
properly assigned to each item. So weights are suitably assigned to each commodity
on the basis of quantity sold, quantity purchased, quantity produced or quantity
spent. The weights differ from one item to another according to their use or
significance or importance. The assignments of weights bring in the uniformity in
the calculation of index numbers.
7. Choice of Method: There are various methods used in computing the different types
of index numbers. The suitability of each method depends upon the factors such
as availability of data, purpose for which index numbers are required and resources
at disposal for constructing index numbers.
Terminologies and notations used in the index number formulas.
0 -Denotes base year & 1 - denotes current year.
𝑃0 = Price of an item in the base year
𝑃1 = Price of an item in the current year
𝑄0 = Quantity of an item (consumed or purchased) in the base year.
𝑄1 = Quantity of an item (consumed or purchased) in the current year.
𝑊 = Weight assigned to an item with reference to its significance or importance.
(The base year, with which the comparisons of the current year are made, indicates
100)
METHODS OF COMPUTING INDEX NUMBERS
The following are some of the important methods of computing the index numbers:
a) Simple Aggregative Method.
b) Weighted Aggregative Method.
c) Simple Average of Price Relatives Method.
d) Weighted Average of Price Relatives Method.
Simple Aggregative Method: Under this method, the aggregate of prices of various
commodities, in a given year, is expressed as a percentage of the same with reference
to the base year. Several values of variables are combined together and the index
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

number is obtained by means of an average. The prices of each commodity in a given

current year are simply added together to and divided by the total of prices in given
base year. The resultant figure is expressed as a percentage.
∑𝑷𝟏
The formula is, 𝑷𝟎𝟏 = × 𝟏𝟎𝟎
∑𝑷𝟎

𝑷𝟎𝟏 = Index Number.

∑𝑷𝟏 = Aggregate of prices of the current year.
∑𝑷𝟎 = Aggregate of prices of the base year.
Example 1
Calculate the price index for the years 1991, 1994 & 1997 by using the simple
aggregative method on the basis of 1980 from the following data:
Prices per Unit
Commodities
1980 (Shs) 1991 (Shs) 1994 (Shs) 1997 (Shs)

Rice (Kg) 1,050 1,210 1,430 1,860

Wheat (Kg) 925 1,140 1,270 1,340

Milk (Ltr.) 475 700 900 1,050

Sugar (Kg) 860 1,400 1,600 1,700

Oil (Ltr.) 2,750 3,200 3,500 3,650

Pulses (Kg) 1,120 1,280 1,310 1,400

Solution:
Computation of Index numbers for 1991, 1994 & 1997
Prices per Unit
Commodities
1980 (Shs) 𝑃0 1991 (Shs) 𝑃1 1994 (Shs) 𝑃1 1997 (Shs) 𝑃1
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

Rice (Kg) 1,050 1,210 1,430 1,860

Wheat (Kg) 925 1,140 1,270 1,340

Milk (Ltr.) 475 700 900 1,050

Sugar (Kg) 860 1,400 1,600 1,700

Oil (Ltr.) 2,750 3,200 3,500 3,650

Pulses (Kg) 1,120 1,280 1,310 1,400

Totals ∑𝑷𝟎 = 𝟕, 𝟏𝟖𝟎 ∑𝑷𝟏 = 𝟖, 𝟗𝟑𝟎 ∑𝑷𝟏 = 𝟏𝟎, 𝟎𝟏𝟎 ∑𝑷𝟏 = 𝟏𝟏, 𝟎𝟎𝟎

∑𝑷𝟏 𝟖,𝟗𝟑𝟎
Index Number for 1991 𝑷𝟎𝟏 𝟏𝟗𝟗𝟏 = × 𝟏𝟎𝟎 𝑷𝟎𝟏 = × 𝟏𝟎𝟎 = 𝟏𝟐𝟒. 𝟒%
∑𝑷𝟎 𝟕,𝟏𝟖𝟎

∑𝑷𝟏 𝟏𝟎,𝟎𝟏𝟎
Index Number for 1994 𝑷𝟎𝟏 𝟏𝟗𝟗𝟒 = × 𝟏𝟎𝟎 𝑷𝟎𝟏 = × 𝟏𝟎𝟎 = 𝟏𝟑𝟗. 𝟒%
∑𝑷𝟎 𝟕,𝟏𝟖𝟎

∑𝑷𝟏 𝟏𝟏,𝟎𝟎𝟎
Index Number for 1991 𝑷𝟎𝟏 𝟏𝟗𝟗𝟕 = × 𝟏𝟎𝟎 𝑷𝟎𝟏 = × 𝟏𝟎𝟎 = 𝟏𝟓𝟑. 𝟐%
∑𝑷𝟎 𝟕,𝟏𝟖𝟎

Therefore, in 1991, prices of commodities increased by 24.4%, 39.4% in 1994 & 53.2% in
1997.
Weighted Aggregative Method: Under this method, the appropriate weights are assigned
to various commodities to reflect their importance individually in the group. The
'weight' may refer to the consumption, purchase or production. Generally, quantities
are used as weights in computing the price index numbers. The current year prices are
multiplied by the base year quantities or weights (𝑃1 𝑄0 ), while the base year prices are
multiplied by the base year quantities(𝑃0 𝑄0 ).
Thus, the sum of the '𝑃1 𝑄0 is divided by the sum of the '𝑃0 𝑄0 ' and the resultant is
∑𝑷 𝑸
expressed in percentage. The formula is, 𝑷𝟎𝟏 = 𝟏 𝟎 × 𝟏𝟎𝟎
∑𝑷𝟎 𝑸𝟎

Example 2
Calculate the weighted aggregative index number for a group of commodities for the
year 2001 & 2008, taking the year 1991 as the base year.
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

Quantity (Price per Unit Shs.)

Commodities
1991 𝑄0 1991 2001 2008

Rice 10 Kg 1,100 1,650 1,800

Wheat 5 Kg 1,020 1,225 1,400

Gram 3 Kg 500 700 900

Milk 30 Ltrs. 670 900 1,050

Ghee 4 Kg 2,900 3,200 3,800

Sugar 12 kg 880 1,130 1,630

Solution:
COMPUTING INDEX No. FOR 2001 & 2008
Weights (Price per Unit Shs.) 1991 2001 2008
Commodities 1991 𝑄0 1991 2001 2008 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟎 𝑷𝟏 𝑸𝟎
𝑷𝟎 𝑷𝟏 𝑷𝟏

Rice 10 1,100 1,650 1,800 11,000 16,500 18,000

Wheat 5 1,020 1,225 1,400 5,100 6,125 7,000

Gram 3 500 700 900 1,500 2,100 2,700

Milk 30 670 900 1,050 20,100 27,000 31,500

Ghee 4 2,900 3,200 3,800 11,600 12,800 15,200

Sugar 12 880 1,130 1,630 10,560 13,560 19,560

TOTAL 59,860 78,085 93,960

2001 2008
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∑𝑷𝟏 𝑸𝟎 ∑𝑷𝟏 𝑸𝟎
𝑷𝟎𝟏 𝟐𝟎𝟎𝟏 = × 𝟏𝟎𝟎 𝑷𝟎𝟏 = × 𝟏𝟎𝟎
∑𝑷𝟎 𝑸𝟎 ∑𝑷𝟎 𝑸𝟎

𝟕𝟖,𝟎𝟖𝟓 𝟗𝟑,𝟗𝟔𝟎
𝑷𝟎𝟏 = × 𝟏𝟎𝟎 𝑷𝟎𝟏 = × 𝟏𝟎𝟎
𝟓𝟗,𝟖𝟔𝟎 𝟓𝟗,𝟖𝟔𝟎

𝑷𝟎𝟏 𝟐𝟎𝟎𝟏 = 𝟏𝟑𝟎. 𝟒𝟓% 𝑷𝟎𝟏 𝟐𝟎𝟎𝟖 = 𝟏𝟓𝟕%

Simple Average of Price Relatives Method: Under this method, "Price Relatives" (I) are
obtained for each commodity. To obtain the index number, the sum of price relatives
is divided by the number of items (n).
A price relative is an index number of the individual item or commodity in a group.
It is the price of the current year expressed as a percentage of the base year (if fixed
base 'year) or the previous year (if chain base year).
The formula is,
∑𝐼 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒 𝑃1
Fixed Base year 𝑃01 = 𝐼= × 100 = × 100
𝑛 𝐵𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒 𝑃0

∑𝐼 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒 𝑃1

Chain Base year 𝑃01 = 𝐼= × 100 = × 100
𝑛 𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑦𝑒𝑎𝑟 𝑃𝑟𝑖𝑐𝑒 𝑃0

𝑃
∑ ( 1 × 100)
𝑃0
𝑃01 =
𝑛
Example 3
Compute the price index number for the following data by using a simple average of
price relative.
Prices (Shs)
Items
2001 2007 2008

Bricks 100 160 180

Timber 200 210 220

Board 500 600 700

Sand 200 300 500

 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

Cement 700 140 210

Solution
Computation of Simple price relative
Year 2007 Year 2008
𝑃1 𝑃1
𝑃01 𝐵𝑟𝑖𝑐𝑘𝑠 = × 100 𝑃01 𝐵𝑟𝑖𝑐𝑘𝑠 = × 100
𝑃0 𝑃0

160 180
𝑃01 = × 100 𝑃01 = × 100
100 100

𝑷𝟎𝟏 = 𝟏𝟔𝟎% 𝑷𝟎𝟏 = 𝟏𝟖𝟎%

𝑃1 𝑃1
𝑃01 𝑇𝑖𝑚𝑏𝑒𝑟 = × 100 𝑃01 𝑇𝑖𝑚𝑏𝑒𝑟 = × 100
𝑃0 𝑃0

210 220
𝑃01 = × 100 𝑃01 = × 100
200 200

𝑷𝟎𝟏 = 𝟏𝟎𝟓% 𝑷𝟎𝟏 = 𝟏𝟏𝟎%

𝑃1 𝑃1
𝑃01 𝐵𝑜𝑎𝑟𝑑 = × 100 𝑃01 𝐵𝑜𝑎𝑟𝑑 = × 100
𝑃0 𝑃0

600 700
𝑃01 = × 100 𝑃01 = × 100
500 500

𝑷𝟎𝟏 = 𝟏𝟐𝟎% 𝑷𝟎𝟏 = 𝟏𝟒𝟎%

𝑃1 𝑃1
𝑃01 𝑆𝑎𝑛𝑑 = × 100 𝑃01 𝑆𝑎𝑛𝑑 = × 100
𝑃0 𝑃0

300 500
𝑃01 = × 100 𝑃01 = × 100
200 200

𝑷𝟎𝟏 = 𝟏𝟓𝟎% 𝑷𝟎𝟏 = 𝟐𝟓𝟎%

𝑃1 𝑃1
𝑃01 𝐶𝑒𝑚𝑒𝑛𝑡 = × 100 𝑃01 𝐶𝑒𝑚𝑒𝑛𝑡 = × 100
𝑃0 𝑃0

140 210
𝑃01 = × 100 𝑃01 = × 100
700 700

𝑷𝟎𝟏 = 𝟐𝟎𝟎% 𝑷𝟎𝟏 = 𝟑𝟎𝟎%

∑𝑰 = 𝟕𝟑𝟓 ∑𝑰 = 𝟗𝟖𝟎

Using Arithmetic mean

 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

𝑃 𝑃
∑( 1 ×100) ∑( 1 ×100)
𝑃0 𝑃0
𝑃01 = 𝑃01 =
𝑛 𝑛
735 980
𝑃01 = 𝑃01 =
5 5

𝑃01 = 147 𝑃01 = 196

Consumer Price Index Number
Consumer price index number (Cost of living index number) is designed to study the
effect of changes in prices on the working class families or consumers. It is the ratio
of monetary expenditures of an individual which secure for him the same standard of
living in two situations differing only in respect of prices.
Factors considered in compiling Consumer price index number
1. Class of People: We have to decide the class of people for which the index number
should be prepared. The working class has got different pattern of living as
compared to the middle class and the rich class.
2. Base Year: Generally, the year that is having normal economic activities will be
selected as the base year. There should not be any fluctuation in the prices of retail
commodities.
3. Family Budget Enquiry: The consumption pattern of a particular class of people can
be ascertained by conducting a family budget enquiry. The enquiry should have
been conducted in the base year.
4. Commodities: The selection of the commodities that are included in the
computation of index number is the most important consideration. The family
budget enquiry provides for the number of commodities used in the index
number. The detailed information about the expenditure of the family on different
items will be provided by the enquiry. Generally, the commodities are Food, Fuel
and Lighting, Clothing and Footwear, Housing and Miscellaneous. The Percentage
expenditure on different items constitutes the weightage to be assigned to each
item.
5. Methods of Computation: There are two methods of computing the consumer price
index number – Aggregate Expenditure Method and Family Budget Method.
Formulas are,
∑𝑷 𝑸
a) Aggregate Expenditure method 𝑷𝟎𝟏 = 𝟏 𝟎 × 𝟏𝟎𝟎
∑𝑷𝟎 𝑸𝟎
∑𝑰𝑾
b) Family budget method 𝑷𝟎𝟏 = × 𝟏𝟎𝟎
∑𝑾
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

The aggregate expenditure method & family budget method will give the same
results, thus, the formulae may be put as under;
∑𝑷𝟏 𝑸𝟎 ∑𝑰𝑾
𝑷𝟎𝟏 = × 𝟏𝟎𝟎 =
∑𝑷𝟎 𝑸𝟎 ∑𝑾
Example 4
Compute consume price index from the following data
Items 𝑸𝟎 𝑷𝟎 𝑷𝟏 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟎

A 50 80 150 4,000 7,500

B 20 90 120 1,800 2,400

C 30 160 200 4,800 6,000

∑𝑷𝟎 𝑸𝟎 = 𝟏𝟎, 𝟔𝟎𝟎 ∑𝑷𝟏 𝑸𝟎 = 𝟏𝟓, 𝟗𝟎𝟎

∑𝑷𝟏 𝑸𝟎 𝟏𝟓, 𝟗𝟎𝟎

𝑷𝟎𝟏 = × 𝟏𝟎𝟎 = × 𝟏𝟎𝟎 = 𝟏𝟓𝟎%
∑𝑷𝟎 𝑸𝟎 𝟏𝟎, 𝟔𝟎𝟎
Uses of Consumer Price Index Number
The consumer price indices are used in solving the various problems by different
people in different fields. The following are the uses of consumer price indices,

 They are useful in wage negotiations and settlements. The wages are adjusted and
dearness allowances are announced on the bases of these indices.
 They are helpful to the government in forming the wage policy, income policy,
price policy, rent control, taxation and general economic policies.
 They are used in measuring the purchasing power of money and real wages or
income.
 They are of much used in analyzing the markets for particular type of goods and
services.

Example 5
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

An enquiry into -the budgets of the Middle class families of a certain city revealed that
on an average the percentage of expenses on the different groups were: Food 45, Rent
15, Clothing 12, Fuel and Lighting 8 and Miscellaneous 20 during the year 2001. The
group index for the current year 2002, as compared with the base year 2001, were
respectively 410, 150, 343, 248 and 285.
Required;
a) Calculate the consumer price index number for the current year 2002. Mr. X was
getting Shs.240,000 wages in the base year.
b) State how much he should get to maintain his former standard of living during the
current year.
Solution:
Computation of consumer price index No. for 2002
Commodities % Expenses (W) Group index (I) IW

Food 45 410 18,450

Rent 15 150 2,250

Clothing 12 343 4,116

Fuel &Lighting 8 248 1,984

Miscellaneous 20 285 5,700

∑W = 100 ∑IW = 32,500

∑𝐼𝑊 32,500
a) 𝑃01 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 = = = 325
∑𝑊 100
325×240,000
b) 𝑀𝑟. 𝑥 𝑆ℎ𝑜𝑢𝑙𝑑 𝑔𝑒𝑡 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 = = 𝑆ℎ𝑠. 780,000
100

Thus, during the base year (100) Mr. x is getting Shs. 240,000 & during the current
year (325), he should get Shs. 780,000
Example 6
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

An enquiry into the budgets of middle class families in Kampala gave the following
information:
2005 Expenses Food Rent Clothing Fuel Miscellaneous

35% 15% 20% 10% 20%

2006 Price Relatives 116,000 120,000 125,000 125,000 150,000

Required;
a) Determine what changes in the cost of living index of 2006 have taken place as
compared to 2005?
b) How much dearness allowance should be given to a worker who was drawing Shs.
200,000 wages in the base year 2005
Solution
Computation of consumer price Index No for 2006
Items (expenditure) % Expenses (W) Group index (I) IW

Food 35 116,000 4,060,000

Rent 15 120,000 1,800,000

Clothing 20 125,000 2,500,000

Fuel 10 125,000 1,250,000

Miscellaneous 20 150,000 3,000,000

∑W = 100 ∑IW = 12,610,000

∑𝐼𝑊 12,610,000
a) 𝑃01 (2006) 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐿𝑖𝑣𝑖𝑛𝑔 𝐼𝑛𝑑𝑒𝑥 = ∑𝑊
= 100
= 𝑆ℎ𝑠. 126,100
126,100×200,000
b) 𝐴 𝑤𝑜𝑟𝑘𝑒𝑟 𝑑𝑟𝑎𝑤𝑖𝑛𝑔 200,000 𝑆ℎ𝑜𝑢𝑙𝑑 𝑔𝑒𝑡 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 = 100
= 𝑆ℎ𝑠. 252,200,000
c) Dearness Allowance Shs. 200,000
Shs. 252,000,000

Shs. 252,200,000 Dearness Allowance = Shs. 252,000,000

Example 7
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

From the following data, calculate consumer price index

Price per Unit (Shs)

Commodities 2009 Expenditure 2010

2009

Food 200 8,000 280

Rent 300 4,800 345

Clothing 20 2,000 50

Fuel 50 1,500 75

Note: Base year expenditure (i.e. 𝑃0 𝑄0 ) is given.

Solution
Computation of Consumer Price Index Number
Commodities 𝑷𝟎 2009 2010 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟎

∗ 𝑸𝟎 𝑷𝟏

Food 200 40 280 8,000 11,200

Rent 300 16 345 4,800 5,520

Clothing 20 100 50 2,000 5,000

Fuel 50 30 75 1,500 2,250

∑𝑃0 𝑄0 = 16,300 ∑𝑃1 𝑄0 = 23,970

𝑬𝒙𝒑𝒆𝒏𝒅𝒊𝒕𝒖𝒓𝒆 𝑃0 𝑄0
Note: ∗ 𝑄0 is obtained by 𝑄0 = =
𝑷𝒓𝒊𝒄𝒆 𝑃0

∑𝑃1 𝑄0 23,970
∴ 𝐶𝑃𝐼 = × 100 = × 100 = 147.06
∑𝑃0 𝑄0 16,300
Purchasing Power of Money
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

The value of money goes on changing from time to time with the changes in the price
line. If the price line rises, the value of money comes down, and vice versa. The
purchasing power of money index indicates the value of money rather than the
number of rupees required to buy a specified quantity. For example, if the price index
is Shs.150, it means we have to pay Shs. 50 more to buy the quantity of goods that
was brought in the base year.
100 100
𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑖𝑛𝑔 𝑝𝑜𝑤𝑒𝑟 𝑜𝑓 𝑚𝑜𝑛𝑒𝑦 = = = 0.66 𝐶𝑒𝑛𝑡𝑠
𝑃𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥 150
Index Number also serves as an important tool in transforming the money income
into the real income. The real income is expressed in terms of value of money. It is
obtained by dividing the money income by the appropriate Price Index. This process
is called "statistical deflation".
𝑀𝑜𝑛𝑒𝑦 𝐼𝑛𝑐𝑜𝑚𝑒 (𝑊𝑎𝑔𝑒)
𝑅𝑒𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒 (𝑊𝑎𝑔𝑒) = × 100
𝑃𝑟𝑖𝑐𝑒 𝑖𝑛𝑑𝑒𝑥
Example 8
From the following data given below, determine the index number of real wages taking
2001 as a base.
Year Average Monthly Consumer Price
wages (Shs) Index (Base 2001)

2001 240 100

2002 264 240

2003 286 260

Solution:
Year wages (Shs) CPI Conversion Real Wage Conversion Real Wage
Index

2001 240 100 240 240 − 100

× 100
100
264
× 100 110
264 240 240 110 45.83
2002 × 100
240
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

286 110
× 100 × 100
260 240
2003 286 260 110 45.83

WEIGHTED AGGREGATIVE METHODS

There are other methods of assigning the weights considered by different experts and
they include the following;
1. Laspeyre’s Method; the French Economist, devised a formula in 1871 for
calculating index number. He took the base year quantities as weights assigned to
prices. The formula is as follows;
∑𝑃1 𝑄0
𝑃01 = × 100
∑𝑃0 𝑄0
2. Paasche’s Method; under this method, the current year quantities are used as
weights. The formula is,
∑𝑃1 𝑄1
𝑃01 = × 100
∑𝑃0 𝑄1
Paasche, the German Statistician, introduced the above formula in 1874 for
calculating index number. He took the current year quantities as weights assigned to
prices.
3. Marshall-Edgeworth’s Method; under this method, the quantities of base year &
the current year are averaged and the average taken as weights. The formula is;
𝑄 + 𝑄1
∑𝑃1 ( 0 ) ∑𝑃1 𝑄0 + ∑𝑃1 𝑄1
𝑃01 = 2 = × 100
𝑄0 + 𝑄1 ∑𝑃 𝑄
0 0 + ∑𝑃 𝑄
0 1
∑𝑃0 ( )
2
Marshall- Edgeworth, the two economists considered both the current year as well as
the base year quantities as weights to avoid the controversy with respect to fixation of
weights. This method considers the ratio of the sum of the numerators of Laspeyre's
and Paasche's method to the sum of their denominators.
4. Fisher's Method: Prof. Irving Fisher, considered both Laspeyre's Method and the
Paasche's Method, and applied the geometric mean (i.e., the root of the product of
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

both the methods). He attempted to find an ideal index number as it confirms the
tests of consistency and behaviour. That is why his formula is called "Fisher's Ideal
Formula". It is also called a "cross - weight" formula shown as under,

∑𝑃1 𝑄0 ∑𝑃1 𝑄1
𝑃01 = √ × × 100
∑𝑃0 𝑄0 ∑𝑃0 𝑄1

Fisher's formula is considered to be an ideal formula of calculating the index number

because,
 It is based on the appropriate average for index number i.e., the geometric mean.
 It considers the quantities of both the base year and current year
 It is free from bias, as it satisfies the two tests i.e. Time Reversal Test & Factor Reversal
Test.
The formula obeys the Time Reversal Test and the Factor Reversal Test (without the
use of 100). These two tests are the real tools of confirming the formula as an ideal
method of index number. Reversibility means changing the base year to the current
year and current year to the base year or changing the place of the prices in the place
of quantities and the place of the quantities in the place of the prices. The system of
‘reciprocal’ is applied in tests.
Example 9
The following information relates to the weekly pay of the wage earners of a company.
Age in years April, 2010 Total Pay April, 2011 Total Pay

Number (Shs) Number (Shs)

Men above 21 350 2,500 300 4,200

Women above 18 400 1,600 1,200 8,000

Youths (Boys) 150 450 100 560

Youths (Girls) 100 250 400 1,540

Required; construct an index of weekly earnings by using:

a) Base year weighting
b) Current year weighting
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

c) Fisher’s Ideal Method

d) Marshall-Edgeworth’s method
Solution:
Computation of Index of Weekly Earnings
April, 2010 April, 2011

No. Pay No. Pay 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟎 𝑷𝟎 𝑸𝟏 𝑷𝟏 𝑸𝟏

(𝑸𝟎 ) (𝑷𝟎 ) (𝑸𝟎 ) (𝑷𝟎 )

350 2,500 300 4,200 875,000 1,470,000 750,000 1,260,000

400 1,600 1,200 8,000 640,000 3,200,000 1,920,000 9,600,000

150 450 100 560 67,500 84,000 45,000 56,000

100 250 400 1,540 25,000 154,000 100,000 616,000

∑𝑷𝟎 𝑸𝟎 ∑𝑷𝟏 𝑸𝟎 ∑𝑷𝟎 𝑸𝟏 ∑𝑷𝟏 𝑸𝟏

= 𝟏, 𝟔𝟎𝟕, 𝟓𝟎𝟎 = 𝟒, 𝟗𝟎𝟖, 𝟎𝟎𝟎 = 𝟐, 𝟖𝟏𝟓, 𝟎𝟎𝟎 = 𝟏𝟏, 𝟓𝟑𝟐, 𝟎𝟎𝟎

a) Base year Weighted Index No. (Laspeyre’s Method)

∑𝑃1 𝑄0 4,908,000
𝑃01 = × 100 = × 100 = 305.32
∑𝑃0 𝑄0 1,607,500
b) Current year weighted Index No. (Paasche’s Method)
∑𝑃1 𝑄1 11,532,000
𝑃01 = × 100 = × 100 = 409.7
∑𝑃0 𝑄1 2,815,000
c) Fisher’s Ideal method

∑𝑃1 𝑄0 ∑𝑃1 𝑄1 4,908,000 11,532,000

𝑃01 = √ × × 100 = √ × × 100
∑𝑃0 𝑄0 ∑𝑃0 𝑄1 1,607,500 2,815,000

= √3.0532 × 4.0966 × 100 = 353.7

d) Marshall- Edgeworth’s method
∑𝑃1 𝑄0 + ∑𝑃1 𝑄1 4,908,000 + 11,532,000
× 100 =
∑𝑃0 𝑄0 + ∑𝑃0 𝑄1 1,607,500 + 2,815,000
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

16,440,000
= × 100 = 371.7
4,422,500
Example 10
Calculate Fisher’s Index Number from the data given below & show that it satisfies
the Time reversal Test & Factor Reversal test.
Commodities A B C D E

2012 Price 10 12 18 20 22

Quantity 49 25 10 5 8

2013 Price 12 15 20 40 45

Quantity 50 20 12 2 5

Solution;
Computation of Fisher’s Ideal Index No.
2012 2013

(𝑸𝟎 ) (𝑷𝟎 ) (𝑸𝟏 ) (𝑷𝟏 ) 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟎 𝑷𝟎 𝑸𝟏 𝑷𝟏 𝑸𝟏

49 10 50 12 490 588 500 600

25 12 20 15 300 375 240 300

10 18 12 20 180 200 216 240

5 20 2 40 100 200 40 80

8 22 5 45 176 360 110 225

∑𝑷𝟎 𝑸𝟎 ∑𝑷𝟏 𝑸𝟎 ∑𝑷𝟎 𝑸𝟏 ∑𝑷𝟏 𝑸𝟏

= 𝟏, 𝟐𝟒𝟔 = 𝟏, 𝟕𝟐𝟑 = 𝟏, 𝟏𝟎𝟔 = 𝟏, 𝟒𝟒𝟓

∑𝑃1 𝑄0 ∑𝑃1 𝑄1 1,723 1,445

𝑃01 = √ × × 100 = √ × × 100
∑𝑃0 𝑄0 ∑𝑃0 𝑄1 1,246 1,106
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

= √1.3828 × 1.3065 × 100 = 134.41

1. Time Reversal test; this test is satisfied when 𝑃01 × 𝑃10 = 1 (Without 100)

∑𝑃1 𝑄0 ∑𝑃1 𝑄1 ∑𝑃0 𝑄1 ∑𝑃0 𝑄0

𝑃01 × 𝑃10 = √ × ×√ ×
∑𝑃0 𝑄0 ∑𝑃0 𝑄1 ∑𝑃1 𝑄1 ∑𝑃1 𝑄0

1,723 1,445 1,106 1,246

√ × × ×
1,246 1,106 1,445 1,723

√1.3828 × 1.3065 × 0.7654 × 0.7232 = √1 = 1

∑𝑃1 𝑄1
2. Factor Reversal Test; this satisfies the equation that 𝑃01 × 𝑄01 =
∑𝑃0 𝑄0

∑𝑃1 𝑄0 ∑𝑃1 𝑄1 ∑𝑃0 𝑄1 ∑𝑃1 𝑄1

𝑃01 × 𝑄01 = √ × ×√ ×
∑𝑃0 𝑄0 ∑𝑃0 𝑄1 ∑𝑃0 𝑄0 ∑𝑃1 𝑄0

1,723 1,445 1,106 1,445

√ × × ×
1,246 1,106 1,246 1,723

1,445 1,445 1,445 ∑𝑃1 𝑄1

√ × = =
1,246 1,246 1,246 ∑𝑃0 𝑄0

Exercises
1. What is an Index Number?
2. Mention any four problems that need a careful thought before constructing index
numbers.
3. State the uses of Index Numbers.
4. Why are index numbers called "Economic Barometers"?
5. Why are weights used in index numbers?
6. What do you understand by consumer price index number?
7. Why the Fisher's formula is called "ideal"?
8. Define "index number". What are its uses?
9. What do you mean by Time Reversal Test? Show how Fisher's Formula satisfies
this test.
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

10.What is base year? What points are considered in the selection of the base year?
11.What are the uses of consumer price index number?
12.What do you mean by the Factor Reversal Test?
13.What is the Time" Reversal Test?
14.Prices and quantities of base year and current year for 8 groups of commodities are
given below;
Price Quantity
Groups
Base year Current year Base year Current year
A 12 20 55 120

B 10 12 100 80

C 14 15 60 80

D 16 18 30 70

E 18 20 40 40

F 20 15 70 60

G 20 16 90 100

H 15 18 80 80
Required; compute,
a) Paasche’s Index No.
b) Laspeyre’s Index
c) Marshall-Edgeworth’s Index
d) Fishers Ideal Index
e) Verify time reversal & factor reversal tests
15.From the following data, prepare the ‘quantity’ index numbers for the year 2018
takin 2008 as the base year
Commodity I Commodity II Commodity III
Year
Price Qty. Price Qty. Price Qty.
2008 5 10 8 6 6 3
 Business Statistics for Economics | Emma Charles 0753-236-367/0787-080-333

2018 4 12 7 7 5 4