The following steps are considered for the construction of price index numbers:
The first and the most important steps in the construction of index numbers is to decide the object for making the index numbers of prices. The prices may be retail or whole-sale. The index numbers of retail prices are called the consumer price index (CPI) numbers and if the whole-sale prices are taken into consideration, the index numbers are called the whole-sale price index numbers. The index numbers of prices may be calculated for a certain locality, for a certain class of people like textile workers or office clerks etc. The index numbers may be required for geographical regions like districts or provinces etc. First of all we decide the purpose of making the index numbers. Once the purpose is decided, then we decide about the scope and the area or the people who are to be considered.
Selection of Commodities:
A list of important commodities is prepared. Those commodities are taken into account which is commonly consumed by the consumers. There is no hard and fast rule about the number of commodities. Only those commodities are considered on which a reasonable amount is spent. The commodities on which the expenditure is meager or they are used only occasionally are not included in the list. Thus the commodities which are representative of the tastes and customs of the people are taken in the list. Dr. Irving Fisher has said that 20 commodities is a small number and 50 commodities is a reasonable number. For construction of wholesale price index numbers, about 80 commodities are taken in the list and for retail-price index numbers about 300 commodities are considered. Sometimes the index numbers of very important commodities like wheat, rice, oil, ghee etc. are calculated. These index numbers are based on about one dozen commodities and are called sensitive price index numbers.
Collection of Price Data:
The most important and difficult step is the collection of prices. The prices are to be taken from the field. For retail price index numbers, retail prices are needed. The prices change from place to place and from time to time. On different shops the prices are different. In actual practice there are many difficulties. Usually some representative shops from where the consumers mostly purchase their items are selected and the prices are taken from those shops. The prices are taken on daily basis and then the weekly and monthly averages are calculated. Finally quarterly or yearly averages are calculated. Some commodities are sold in different varieties. Rice, sugar, mangoes, etc. have different variables which are sold on different prices. This problem is solved by assigning due weights to different varieties and then weighted average prices is calculated. Sometimes different varieties are treated as different commodities.
For whole-sale prices, the prices are taken from the whole-sale markets, fractions depots and the whole-sale agencies. The whole-sale prices are usually stable, therefore these prices are not taken on daily basis. The price reporting is done on weekly or monthly basis depending upon the nature of the commodity. The prices of some commodities are controlled by the government. These prices are reported whenever some change takes place.
Selection of Base Period:
The prices of the commodities in the current period are to be compared with the prices of some period in the past. This period in the past is called the base period or the reference period. The base period is decided statistical division of Government. This period should not be in the remote past. The period which is economically stable and is free of disturbances and strikes is taken as the base period.