uses of index numbers1 establishes trendsindex

Question

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

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.