Index Number Construction

Index Numbers

An index number, according to economics, is a statistical device that is used for measuring the changes in the magnitude of a group related variables and consisted of axiomatic, economic theoretic and stochastic approaches (NCERT, 2006; and Grifell, 2007). Index number is used as the representation the general trend of diverging ratios, from which it is calculated and usually measures the average change in related variables over the two different situations such as the comparison between the categories of person, schools, business settings, etc. In addition, the index number also measures changes the values of the variables such as prices of specified list of commodities, volume of production in different sectors of an industry, production, etc. The index numbers are only misused if the person does not have enough knowledge to analyze the statistics appeared in the presentation.

The base year is also called the base period where the basis of data is taken and the comparison is executed. It is identified that the value in the base period is given the index number 100. The items included are also called as the commodities and may come in the variety of necessities that are involved in the measurement of an index. The commodities may be in a form of food, supplies in agriculture, e.g. tobacco, rice; fuel, light, housing, clothing, miscellaneous, etc. The said commodities are also included in the presentation and which are the basis for category to identify what is being computed or being compared. The common choice of weights is based on the price index, production index, and quantity index. The price index is numbers that permits the comparison of the prices of commodities or certain goods. Meanwhile, the quantity index numbers measure the changes in the physical volume of production, construction, or employment depending on the purpose of the index. And the production index is used as an important indicator of the level of the output in the economy (NCERT, 2006).

Purpose of the Indexes

There are many types of index numbers and their purpose depends on what kind of index number or computation they represent (Diewert, 2001).

Consumer Price Index or CPI is also known as the cost of living index that measures the average of the retail prices. For industrial workers is considered as the appropriate indicator of general inflation, which shows the most accurate impact of prices rise on the cost of living of common people. What important is the indicator can measure the capability of the worker to buy the said commodity.

Wholesale Price Index indicates the change in general price level but unlike the CPI, it does not have any reference consumer category and does not include items pertaining to several services. WPI use the commodity as its weights and estimated as the value of the commodity in domestic production and the value of imports during the base year.

Industrial Production Index is an index number that measures the changes in the level of industrial production in many industries. This includes the production of the public and the private sector. It is a weighted average of quantity relatives which is also applied in agricultural production. The base year is different from the other because it has triennium ending (e.g. 2004-2005).

Producer Price Index number measures the price changes from the producers’ perspective. The index only uses the basic prices including taxes, trade margins, and transport costs.

Application of Quantitative Methods

In Accounting

Based on the accounting literature, the reference price in the index is considered as part of their property known as additivity or additive consistency and became popular in national income accountants and business economists. The business accounting framework also applied the concept of price allocation or purchase price being distributed or allocated across the period. In addition, the CPI is also based model of the accountants to determine the consumption of fixed capital, although there many restrictions or limitation between the relationship of accounting and index numbers such as the term “interest” that followed with different meanings (Diewert, 2001).

In Financial Management

Most of the business sectors adapted various concepts from economics. And the most popular concept being applied is the interest that is being specified in the representation of an index. The rate of interest or interest return is paid importance attention by the financial analysts seeking for a chance to manage additional financial capital (Diewert, 2001). One basic example is the interest applied in a price of a certain commodity; the price is the exact amount of the commodity with an addition of interest to pay the lender for his use of financial capital for a specified time period.

In Marketing

The commonly used index number by the marketing is the wholesale price index (APDES, 2007). In addition, they can also apply the concept of consumer price index to determine the deflation or inflation in the market. The traditional economic model holds the commodities which is also important in marketing aspect that can lead to innovation, need for additional resources, development, and production improvements. The marketing and advertising of new products is another economic approach that deals with scientific, engineering, and marketing effort is going into the development of new products and can change the welfare and productivity (Diewert, 2001).

In Human Resource Management

Since human resource management is the one who is capable in declaring and computing the salary or wages of the employee, it is also important for them to identify the process in the market. The applied principle that the human resource adopted is the rules pertaining to the salary and wages that they should satisfy the cost of living of the employee as well as his or her dependents and can still accommodate the chance to save and is also called as cost of living allowance for some countries.

References:

APDES, (2007). “Prices, Wages and Index Numbers” Accessed 27 Jan 2010, from http://www.apdes.ap.gov.in/Publications07-pdf/Prices-Wages-Index-Numbers.pdf

Diewert, E., (2001). “The Consumer Price Index and Index Number Purpose”. Journal of Economic and Social Measurement, Vol. 27. Accessed 27 Jan 2010, from http://econ.arts.ubc.ca/diewert/purpose.pdf

Grifell, E., (2007). “A Review of basic index Number Methods”. Incentives and Efficiency Evaluations. Accessed 27 Jan 2010, from http://demo.uib.es/pdfs/TutorialPrasadaRao.pdf

NCERT, (2006). “Index Numbers” Accessed 27 Jan 2010, from http://www.ncert.nic.in/book_publishing/CLASS%2011/statististics/ch8.pdf