Statistics For Management

Index Numbers
Definition

According to Morris Hamburg defined, an index number is nothing

more than a relative number, which expresses are relationship
between two figures, where one of the figure is used as a base.

Uses of Index Number:

 They measure the relative change.

 They are of better comparison.

 They are economic barometers.

 They compare the standard of living.

 They provide guidelines to policy.

 They measure the purchasing power of money.

Characteristics & Methods of Index Number

Characteristics:

1). Index numbers are specified averages.

2).Index numbers are expressed in percentage.

3). Index numbers measure changes.

4). capable of direct measurement.

5). Index numbers are for comparison.

Various Methods Index Numbers

 Unweighted Simple Aggregate Index Number

 Unweighted Simple Average Price Relative Index

 Weighted Aggregate Index Number ; That is

 * Laspeyre’s Method

 * Paasche’s Method

 * Fisher’s Ideal Method

 * Bowley’s Method

 * Marshall-Edgeworth Method

 * Kelly’s Method
Types of Index Numbers
 Price Index:
 Compares the prices for a group of commodities at a certain time as at a
place with prices of a base period. The wholesale price index reveals the
changes into general price level of a country, but the retail price
index reveals the changes in the retail price of commodities such as
consumption of goods, bank deposits, etc.
 Quantity Index:
 Is the changes in the volume of goods produced or consumed. They are
useful and helpful to study the output in an economy.
 Value Index:
 Compare the total value of a certain period with total value in the base
period. Here total value is equal to the price of commodity multiplied by the
quantity consumed.
 Notations
• The following notations would be used through out the Presentation:
• P1 = Price of current year
• P0 = Price of base year
• q1 = Quantity of current year
• q0 = Quantity of base year
 Problems in construction of Index Numbers

• Purpose of the index numbers

• Selection of base period

• Selection of items

• Selection of source of data

• Collection of data

• Selection of average

• System of weighting
Methods of Index Number
1. Laspeyres Index Method
2. Paasche’s Method
3. Bowley Method
4. Fisher’s ideal Method
5. Marshall Edworth Method
6. Kelly’s Method
Laspeyres Index Method

This method was devised by Laspeyres in 1871.In this

method the weights are determined by the quantities base.
Merits
1.Laspeyres index is simpler in calculation and can be
computed
2) once the current year prices are known, as the weight are
base year quantities in a price index.
3) This enables us an easy comparability of one index with
another.
Laspeyres Index Method (contin)

∑P1Q0
• Laspeyres Index Method = -------- x 100
∑P0Q0
• P1 = Prices in the current year
• P0 = Prices in the base year
• Q1 = Quantities in the current year
• Q0 = Quantities in the base year
 Paasche’s Method

• This method was devised by a German statistician

Paasche in 1874. The weights of current year are used
as base year in constructing the Paasche's Index. The
Paasche index can be calculated using the following
formula.
∑P1Q1
• Paasche Price Index = --------- x100
∑P0Q1
• Where,
• P1 = Prices in the current year
• P0 = Prices in the base year
• Q1 = Quantities in the current year
Fisher’s Method

• Fisher’s ideal index is the geometric mean of Laspeyre and

paasche methods.
P01 F = √ [ P01L x P01P]
• Fisher’ s ideal Method: It is known as ideal index number
because:
• (a) It is based on the geometric mean.
• (b) It is based on the current year as well as the base year.
• (c) It conform certain tests of consistency.
• (d) It is free from bias
 Illustration 1 - Weighted Aggregate index number

• Compute the weighted aggregative price index numbers for with as base
year using (1) Laspeyre’s Index Number (2) Paashe’s Index Number (3)
Fisher’s Ideal Index Number.

Commodity Base year Current year Base year Current year

Price Price Quantities Quantities

Wheat 6 10 50 50
Sugar 2 2 100 120
Rice 4 6 60 60
Milk 10 12 30 25
 Solution: Weighted Aggregate index number

Price ($) Price Qty Qty

Commodity (B.Y) ($)(C.Y) (B.Y) (C.Y) P0Q0 P1Q0 P0Q1 P1Q1
(P0) (P1) (Q0) (Q1)
Wheat 6 10 50 50 300 500 300 500
Sugar 2 2 100 120 200 200 240 240
Rice 4 6 60 60 240 360 240 360
Milk 10 12 30 25 300 360 250 300
∑P0Q0 ∑P1Q0 ∑P0Q1 ∑P1Q1
=1040 =1420 =1030 =1400
 Solution ( continu)
∑ P1Q0 1420
 Laspeyres Index Method = --------- x 100 ----------x 100 = 136.54
∑P0Q0 1040
∑P1Q1 1400
 Paasche Price Index = ---------- x 100 --------- x 100 = 135.92
P0Q1 1030
 Fisher’s Ideal Index Method = √ L x P = √ 136.54 x 135.92 = √ 185322.57 = 136.13
Illustration 2
From the data given below , construct index number of prices for 2006with 2000 as base using 1)
Laspeyre’s Index 2 ) Paache ‘ s Method and Fisher ideal Index Method.

Year 2000 Year 2006

Commodity Price Per Unit Expenditure in Price Per Unit Expenditure in

Rupees Rupees
A 2 10 4 16

B 3 12 6 18

C 1 8 2 14

D 4 20 8 32
 Solution
Since we are given price and total expenditure for the year 2000 and 2006 , we shall first
calculate the quantities for two years by dividing the expenditure by price , and then we
shall calculate the index numbers is as follows:

Commo P0 q0 P1 q1 Po qo poq1 p1q0 p1q1

dity
A 2 10/2=5 4 16/4=4 10 8 20 16

B 3 12/3=4 6 18/6=3 12 9 24 18

C 1 8/1=8 2 14/2=7 8 7 16 14

D 4 20/4=5 8 32/8=4 20 16 40 32

∑Po qo ∑poq1 ∑p1q0 ∑p1q1

= 50 = 40 = 100 = 80
Continue
∑ P1Q0 100
 Laspeyres Index Method = ------- x 100 = --------------x 100 = 200
 ∑P0Q0 50
 ∑P1Q1 80
 Paasche Price Index = ---- ----- x 100 ------------- x 100 = 200
 P0Q1 40
 Fisher’s Ideal Index Method = √ L x P = √ 200 x 200 = √ 40000 = 200
 Additional Problem
Calculate the Index number of prices and quantity index for the following data, using
Laspeyres & Fisher’s Ideal formula.

Commodity Unit (Per) Unit Price Quantity

Year : 2000 Year : 2010 Year : 2000 Year : 2010
A Meter 25 35 2500 2000
B Kg 7 10.50 1000 900
C Hundred 4 5 600 600
D Ton 1000 1100 100 120
E Cubic foot 2.00 2.50 9000 10000
Additional Problem in Weighted Aggregate index
number
 University Exam Question:

Problem: Bill Simpson, owner of a California Vineyard , has collected the following information
describing the prices and quantities of harvested crops for the years 1992-1995.

Price Per Ton Quantity Harvested (tons)

1992 1993 1994 1995 1992 1993 1994 1995

Ruby $108 $109 $113 $111 1280 1150 1330 1360
cabemet
Barbera $93 $96 $96 $101 830 860 850 890
Chenin $97 $99 $106 $107 1640 1760 1630 1660
blanc

Construct a Laspeyres Index and Fisher’s Index for each of this 4 years using 1992 as the base period.
 Answer:

1992-93 1992-93 1992-93

Commodity
p1q0 p0q0 p1q0 p0q0 p1q 0 p0q0
Ruby 139520 138240 144640 138240 142080 138240
cabemet
Barbera 79680 77190 79680 77190 83830 77190

Chenin 159080 159080 173840 159080 175480 159080

blanc
∑p1q0 ∑p0q0 ∑p1q0 ∑p0q0 ∑p1q0 ∑p0q0
378280 374510 398160 374510 401390 374510
 Solution: Help to Find out Fisher’s Ideal Index
1992-93 1992-93 1992-93

Com
modi p1q0 p0q0 p1q1 p0q1 p1q0 p0q0 p1q1 p0q1 p1q 0 p0q0 p1q1 p0q1
ty
Ruby 139520 13824 12535 12420 14464 13824 15029 14364 14208 138240 150960 146880
cabe 0 0 0 0 0 0 0 0
met

Barb 79680 77190 82560 79980 79680 77190 81600 79050 83830 77190 89890 82770
era

Cheni 159080 15908 17424 17072 17384 15908 17278 15811 17548 159080 177620 161020
n 0 0 0 0 0 0 0 0
blanc
∑p1q0 ∑p0q0 ∑p1q1 ∑p1q1 ∑p1q0 ∑p0q0 ∑p1q1 ∑p0q1 ∑p1q0 ∑p0q0 ∑p1q1 ∑p0q1
378280 37451 38215 37490 39816 37451 40467 38080 40139 374510 418470 390670
0 0 0 0 0 0 0 0
Continue

1992-93 year Laspeyres Index :

∑p1q0 378280
Laspeyres Index Method = ------- x 100 -------------- x 100 = 101.01
∑p0q0 374510
1992-94 year Laspeyres Index :

∑p1q0 398160
Laspeyres Index Method = ------- x 100 -------------- x 100 = 106.31
∑p0q0 374510
1992-95 year Laspeyres Index :
∑p1q0 401390
Laspeyres Index Method = ------- x 100 -------------- x 100 = 107.18
∑p0q0 374510
 Index Number Test
 Time Reversal Test :

 A test used with index numbers that is satisfied when the new index is the
reciprocal of the original index if the functions of the base period and given
period are interchanged; the advantage of index numbers meeting the
criteria of the test is that a symmetric comparison of the two periods is
obtained and the results are consistent whether one or the other period is
used as a base.
 Factor Reversal Test:

 A test for index numbers in which an index number of quantity, obtained if

symbols for price and quantity are interchanged in an index number of price,
is multiplied by the original price index to give an index of changes in total
value.
 Fisher’s Index–Time& Factor Reversal test
Calculate Fisher’s Index number from the following data and prove
that it satisfied both the time reversal test and factor reversal test.

Commodity Price $ Quantity Price $ Quantity

2006 2006 2007 2007

Food 6 50 10 56

Fuel & Lighting 2 100 2 120

Clothing 4 60 6 60

House Rent 10 30 12 24

Miscellaneous 8 40 12 36
 Solutions in Weighted Aggregate index number

Commodit Price ($) Price Qty Qty

y (B.Y) ($)(C.Y) (B.Y) (C.Y) P1Q0 P0Q0 P1Q1 P0Q1
(P0) (P1) (Q0) (Q1)
Food 6 10 50 56 500 300 560 336

Fuel 2 2 100 120 200 200 240 240

Clothing 4 6 60 60 360 240 360 240

House 10 12 30 24 360 300 288 240

Rent
Miscellane 8 12 40 36 480 320 432 288
ous
∑p1q0 ∑p0q0 ∑p1q1 ∑p0q1
=1900 =1360 = 1030 = 1400
Continue : Time Reversal Test

∑p1q0 1900
Laspeyres Index Method = ------- x 100 -------------- x 100 = 139.70
∑p0q0 1360
∑p1q1 1030
Paasche Price Index = ---- ----- x 100 ---------- x 100 = 73.57
p0q1 1400

Fisher Ideal Index = √LxP = √ 139.70 x 73.57 = √ 10277.73 = 101.38

Time Reversal Test: P01 x P10 = 1
∑p1q0 ∑p1q1 ∑p0q1 ∑ p0qo
P01 x P10 = √ ---------- x ---------- x ------ x ---------
∑p0q0 ∑ p0q1 ∑ p1q1 ∑p1q0
1900 1030 1400 1360
P01 x P10 = √------ x ------ x -------x -------- = √1 =1
1360 1400 1030 1900
Hence time reversal test is satisfied.
Continue ; Factor Reversal Test

Factor reversal test is satisfied when

∑p1q1
P01 x q01 = ----------
∑p0q0
∑p1q0 ∑p1q1 ∑p0q1 ∑ p1q1
P01 x q01 = √ ---------- x ---------- x ------ x --------- = √1 =1
∑p0q0 ∑ p0q1 ∑ p0q0 ∑p1q0
1900 1030 1400 1030 1030 1030 1030 ∑ p1q1
P01 x P10 = √------ x ------ x -------x -------- = √ --------- x -------- = ------- = ---------
1360 1400 1360 1900 1360 1360 1360 ∑ p0q0

Hence, factor reversal test is satisfied by the given data.

 Illustration.2
From the data given below Calculate the Price Index by Fisher’s Ideal formula and then
verify the Fisher’s Ideal formula satisfies both time reversal test and factor reversal test.

Base Year Current Year

Commodity Price (R.s) Qty (000) Price (R.s) Qty (000)

Tonnes Tonnes

Rice 56 71 50 26

Pulses 32 107 30 83

Sugar 41 62 28 48
 Solution: Calculation of Fisher Ideal Index

Commodity p0 q0 p1 q1 p0q0 p0q1 p1q0 p1q1

A 56 71 50 26 3976 1456 3550 1300
B 32 107 30 83 3424 2659 3210 2490
C 41 62 28 48 2542 1968 1736 1344
∑ p0q0 ∑ p0q1 ∑p1q0 ∑p1q1
9942 6083 8496 5134

Fisher Ideal Index price = ∑p1q0 ∑p1q1 8496 5134

P01 x P10 = √ ---------- x ---------- = √ -------- x ---------- x 100
∑p0q0 ∑ p0q1 9942 6083
√0.8544 x 0.844
= .8492 x 100 = 84.92
 Time and Factor Reversal Test
Time Reversal Test: P01 x P10 = 1
∑p1q0 ∑p1q1 ∑p0q1 ∑ p0qo
P01 x P10 = √ ---------- x ---------- x ------ x ---------
∑p0q0 ∑ p0q1 ∑ p1q1 ∑p1q0
8496 5134 6083 9942
P01 x P10 = √------ x ------ x -------x -------- = √1 =1
9942 6083 5134 8496
Hence time reversal test is satisfied.
Factor reversal test is satisfied when
∑p1q1
P01 x q01 = ----------
∑p0q0
∑p1q0 ∑p1q1 ∑p0q1 ∑ p1q1
P01 x q01 = √ ---------- x ---------- x ------ x --------- = √1 =1
∑p0q0 ∑ p0q1 ∑ p0q0 ∑p1q0
8496 5134 6083 5134 5134 5134 5134 ∑ p1q1
P01 x P10 = √------ x ------ x -------x -------- = √ --------- x -------- = ------- = ---------
9942 6083 9942 8496 9942 9942 9942 ∑ p0q0
Hence, factor reversal test is satisfied by the given data.
 Additional Problem
From the data given below Calculate the Price Index by Fisher’s Ideal formula and then
verify the Fisher’s Ideal formula satisfies both time reversal test and factor reversal test.

2005 2010

Commodity Price (R.s) Qty (000) Price (R.s) Qty (000)

Tonnes Tonnes

Bricks 20 8 40 6

Timber 50 10 60 5

Sand 40 15 50 10

Cement 20 20 20 15