Index Numbers — Economics STD 11 Commerce — Question

This is the simplest method of constructing index numbers. When this method is used to construct a price index number the total of current year prices for the various commodities in question is divided by the total of the base year prices and the quotient is multiplied by 100.

$₹ \text{ Symbolically}\text{ P}_{01}=\frac{\sum\text{P}_1}{\sum\text{P}_0}\times100$

Where $P_o$ are the base year prices $P_1$ are the current year prices $P_{o1}$ is the price index number for the current year with reference to the base year.

When this method is used to construct a price index number, first of all price relatives are obtained for the various items included in the index and then the average of these relatives is obtained using any one of the averages i.e. mean or median etc.

$\text{P}_01=\frac{1}{\text{n}}\sum\bigg(\frac{\text{P}_1}{\text{P}_0}\times100\bigg)$

It is not affected by the units in which prices are quoted.

It gives equal importance to all the items and extreme items don't affect the index number.

The index number calculated by this method satisfies the unit test.

It is simple to calculate and easy to understand.

It gives a rough idea of change.

There are two main limitations of this method. The units used in the prices or quantity quotations have a great influence on the value of index.

No considerations are given to the relative importance of the commodities.

Since it is an unweighted average the importance of all items are assumed to be the same.

The index constructed by this method doesn't satisfy all the criteria of an ideal index number.