Index numbers are meant to study changes in the effects of factors which cannot be measured directly. According to Bowley, “Index numbers are used to measure the changes in some quantity which we cannot observe directly”. For example, changes in business activity in a country are not capable of direct measurement, but it is possible to study relative changes in business activity by studying the variations in the values of some such factors which affect business activity, and which are capable of direct measurement.
Index numbers are a commonly used statistical device for measuring the combined fluctuations in group-related variables. If we wish to compare the prices of consumer items today with their prices ten years ago, we are not interested in comparing the prices of only one item, but in comparing average price levels. We may wish to compare the present agricultural production or industrial production with that at the time of independence. Here again, we have to consider all items of production and each item may have undergone a different fractional increase (or even a decrease). How do we obtain a composite measure? This composite measure is provided by index numbers, which may be defined as a device for combining the variations that have occurred to a group of related variables over a period of time, to obtain a figure that represents the ‘net’ result of the change in the constitute variables.
Index numbers may be classified in terms of the variables that they are intended to measure. In business, different groups of variables in the measurement of which index number techniques are commonly used are (i) price, (ii) quantity, (iii) value and (iv) business activity. Thus, we have an index of wholesale prices, index of consumer prices, index of industrial output, index of value of exports and index of business activity, etc. Here we shall be mainly interested in index numbers of prices showing changes with respect to time, although the methods described can be applied to other cases. In general, the present level of prices is compared with the level of prices in the past. The present period is called the current period and some period in the past is called the base period.
Index numbers are statistical measures designed to show changes in a variable or group of related variables with respect to time, geographic location or other characteristics such as income, profession, etc. A collection of index numbers for different years, locations, etc., is sometimes called an index series.
Simple Index Number
A simple index number is a number that measures a relative change in a single variable with respect to a base.
Composite Index Number
A composite index number is a number that measures an average relative changes in a group of relative variables with respect to a base.
Types of Index Numbers
The following types of index numbers are usually used: price index numbers and quantity index numbers.
Price Index Numbers
Price index numbers measure the relative changes in the price of a commodity between two periods. Prices can be either retail or wholesale.
Quantity Index Numbers
These index numbers are considered to measure changes in the physical quantity of goods produced, consumed or sold for an item or a group of items.