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Uses of Index Numbers
1. Establishes trends
Index numbers when analyzed reveal a general trend of the phenomenon under study. The available figures for inflation based on wholesale price index and consumer price index suggest that in 1993, inflation is lower than that in the earlier three years and was the highest in 1991 and started declining subsequently. Refer the table on the next page.
2. Helps in policy making
It is widely known that the dearness allowance paid to the employees is linked to the cost of living index, generally the consumer price index. From time to time it is the cost of living index which forms the basis of many a wage agreement between the employees union and the employer. Thus index numbers guide policy making.
3. Determines purchasing power of the rupee
Usually index numbers are used to determine the purchasing power of the rupee. Suppose the consumer price index for urban non-manual employees increased from 100 in 1984 to 202 in 1992, the real purchasing power of the rupee can be found out as follows: 100/202 = 0.495
Usually index numbers are used to determine the purchasing power of the rupee. Suppose the consumer price index for urban non-manual employees increased from 100 in 1984 to 202 in 1992, the real purchasing power of the rupee can be found out as follows:
100/202
It indicates that if rupee was worth 100 paise in 1984 its purchasing power is 49.5 paise in 1992.
4. Deflates time series data
Index numbers play a vital role in adjusting the original data to reflect reality. For example, nominal income (income at current prices) can be transformed into real income (reflecting the actual purchasing power) by using income deflators. Similarly, assume that industrial production is represented in value terms as a product of volume of production and price. If the subsequent year's industrial production were to be higher by 20% in value, the increase may not be as a result of increase in the volume of production as one would have it but because of increase in the price. The inflation which has caused the increase in the series can be eliminated by the usage of an appropriate price index and thus making the series real. Construction of Real Wage Indices Year Nominal wages (Rs.) Consumer price index Real wages (Rs.) Real wage index (base 1985 = 100) (a) (b) (c = (a/b) * 100 ) (d = (c/a, base)*100 ) 1985 900 100 900.00 100.00 1986 950 108 879.63 97.74 1987 1020 117 871.79 96.87 1988 1050 131 801.53 89.06 1989 1100 148 743.24 82.58 1990 1200 155 774.19 86.02 1991 1275 175 728.57 80.95 1992 1400 180 777.78 86.42 When the actual time series i.e. nominal wages is deflated using the consumer price index, we find that real wages have been generally decreasing though the nominal wages are increasing. The situation is very well reflected by the real wage index.
Index numbers play a vital role in adjusting the original data to reflect reality. For example, nominal income (income at current prices) can be transformed into real income (reflecting the actual purchasing power) by using income deflators. Similarly, assume that industrial production is represented in value terms as a product of volume of production and price. If the subsequent year's industrial production were to be higher by 20% in value, the increase may not be as a result of increase in the volume of production as one would have it but because of increase in the price. The inflation which has caused the increase in the series can be eliminated by the usage of an appropriate price index and thus making the series real.
Construction of Real Wage Indices
Year
Nominal wages
(Rs.)
Consumer price index
Real wages (Rs.)
Real wage index (base 1985 = 100)
(a)
(b)
1985
900
100
900.00
100.00
1986
950
108
879.63
97.74
1987
1020
117
871.79
96.87
1988
1050
131
801.53
89.06
1989
1100
148
743.24
82.58
1990
1200
155
774.19
86.02
1991
1275
175
728.57
80.95
1992
1400
180
777.78
86.42
When the actual time series i.e. nominal wages is deflated using the consumer price index, we find that real wages have been generally decreasing though the nominal wages are increasing. The situation is very well reflected by the real wage index.
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