How to Calculate an Index Number

An index number is a percentage value designed to measure the over all change in a variable, or in a group of related variables, by reference to a base value. In other words it is a number that measures the change in a variable over time. For example an index number is used to measure changes in national income, employment, production, wages, prices etc over a period of time. The function of index number is two fold, i.e. on one hand it reduces large numbers into simple percentages which are easy and convenient for the purpose of comparisons. And on other hand it reveals the secret information about the actual position of an organization. In many cases businessmen are often reluctant to give out information concerning sales, profits etc. but with the help of index numbers it is easy to find whether a firms’ sales, profit, cost etc. have increased or decreased over a period of years. Two types of periods are used for the purpose of comparisons i.e. base period and current period. The year under comparison is called current year and the year with which comparison is made is called the base year.

 

Types of Index Measures

 

The purpose of index number is to compare the measurements but these measurements can be concerned with quantity, price or value. This results in three different types of index measures which are given as:

 

• Price Index Number

Price index compares changes in prices from one period to another. For example a price index of 120 for a particular commodity would indicate that the price in the given period was 20 percent higher than the price in the base period. The important examples of price index number are wholesale price index and cost of living index.

 

• Quantity Index Number

 

Quantity index number shows how much quantity of a variable changes over time. So basically it measures the changes in the quantity of goods produced or consumed during given period of time with reference to base period. For example an index number of 130 for fertilizer would mean that the sales of fertilizer in given period were 30 percent higher than the sales in the base period. The important examples of quantity index number are industrial production index and business activity index.

 

•    Values Index Number

 

Values Index Number measures changes in total monetary worth. It is such type of index number which represents the changes in both price and quantity. Thus we can conclude that a values index number compares the total value of production or sales over a period of time without regard to whether the observed difference is a result of differences in, price, quantity or both. The important examples of values index number are index of retail sales and index of gross national product.

 

Types of Index Numbers on the basis of number of commodities

 

Simple Index Number

Simple index number is the ratio of two prices of a single commodity at two different time periods, expressed as a percentage. For example, a price index for per unit price of a commodity in January 2000 compared with January 2002 would be a simple price index. In order to see the calculation of simple price index or price relative click here.