Economics 3 Marks Question

In India, there are three consumer price indices which are constructed. These are:

1. Consumer Price Index for Industrial I workers with 1982 as base ear. It is published by Labour Bureau, Shimla.
2. Consumer Price Index for urban non manual employees with 1984-5 as base year. It is published by Labour Bureau, Shimla.
3. Consumer Price Index for agricultural labourers with 1986-87 as base year. It is published by Central Statistical Organsation (CSO).

These indices are calculated every month to find the changes in cost of living of these workers.

1. Source of prices should be taken from places that represent the entire population.
2. A choice needs to be made between wholesale prices and retail prices. It will depend on purpose of index numbers.
3. If the prices of certain commodities are controlled by the government, then administered prices are taken for index numbers.
4. The sources from which price quotations are taken must be reliable.

Index numbers are used as economic barometers. Index number is a special type of averages which helps to measure the economic fluctuations on price level, money market, economic cycle like inflation, deflation etc. G.Simpson and F.Kafka They are used to take the pulse of economy and they are used as indicators of inflation or deflation tendencies. So index numbers are called economic barometers.

Since index numbers are specialized averages, a choice of average to be used in their construction is of great importance. Usually the following averages can be used.

1. Arithmetic Mean.
2. Geometric Mean.
3. Median.

Among these averages Geometric Mean is the appropriate average to be used. But in practice Geometric Mean is not used as often as Arithmetic Mean because of its computational difficulties.Median has erratic difficulties.

In India for the construction of Wholesale Price Index, goods are mainly classified into the following three groups:

1. Primary Articles.
2. Energy Articles.
3. Manufacturing Articles.

An index number is a statistical device for measuring relative change in a group of related variables like prices, production etc. over two or more different time periods. In other words, an index number is defined as a specialised type of average which measures changes in the price of commodity, industrial production, cost of living, etc.The two features of index numbers are:

1. They are expressed in percentages.
2. They are special types of averages.

Consumer Price Index (CPI) is the index which measures the average change in retail prices.The two uses of Consumer Price Index are:

1. It is helpful in wage negotiation.
2. It is helpful in the formulation of general economic policy, as it is considered to be appropriate indicator of general inflation, which shows the most accurate impact of price rise on the cost of living of common people.

Sometimes it is difficult to distinguish bit a year which can be taken as a normal year and hence the average of a few years may be regarded as the value corresponding to the base year.

This method is not affected by change in the units of measurement or by extreme values. However, it suffers from the following limitations:

1. This method also gives equal weights to all the items and thus ignores their relative importance in the group.
2. This method uses arithmetic mean for computing average, which is not suitable for study of index numbers.

Index numbers are an important statistical device used for measuring relative change in a large number of items. They are called 'economic barometers'.The two importance of index numbers are:

1. They are indispensable in economic policy making.
2. They measure and permit comparison of the prices of certain goods.

The three limitations of index numbers are:

1. Index numbers are not fully true. They simply indicate arithmetical tendency of the temporal change in the variable.
2. Index numbers do not help in international comparison.
3. Index numbers are prepared with certain specific objectives.
4. It is difficult to collect retail prices so index numbers based on wholesale prices may be misleading.

The four uses of Wholesale Price Index Numbers are:

1. WPI is used to measure the rate of inflation.
2. WPI is used as an indicator of changes in economy.
3. WPI is used to forecast the demand and supply of the commodities in the economy.
4. WPI can be used to estimate the monetary value and real value of aggregates like national income.

The following are the basic criteria for the choice of the base period:

1. The base period must be a normal period i.e. a period frees from all sorts of abnormalities or random fluctuations such as labor strikes, wars, floods, earthquakes etc.
2. The base period should not be too distant from the given period. Since index numbers are essential tools in business planning and economic policies the base period should not be too far from the current period. For example for deciding increase in dearness allowance at present there is no advantage in taking 1950 or 1960 as the base, the comparison should be with the preceding year after which the DA has not been increased.
3. Fixed base or chain base. While selecting the base a decision has to be made as to whether the base shall remain fixing or not i.e. whether we have fixed base or chain base. In the fixed base method the year to which the other years are compared is constant. On the other hand, in chain base method the prices of a year are linked with those of the preceding year. The chain base method gives a better picture than what is obtained by the fixed base method.

Price Index Numbers: Price index number measures the changes in the price level of one commodity or group of commodities between two points of time or two areas. Ex: Wholesale price index numbers; Retail price index numbers, Consumer price index numbers.
Quantity index number: Quantity index numbers measures the changes in the volume of production, sales, etc in different sectors of economy with respect to time period or space. For example, indices of agriculture production, industrial production, exports, imports etc.

Some of the variables in which changes are studied with the help of index numbers are:

1. Prices of commodities like wheat, gold, steel, consumer goods, cereals, etc.
2. Volume of trade, factory production, industrial and agriculture production, exports or imports, prices of stocks or shares, sales and profits of a firm, etc.
3. National income of a country, wage structure of workers in various sectors, cost of living of persons of a particular community, class or profession, etc.

Primary data is collected every month to compute rural and urban CPI in the following ways:

1. For CPI (Rural), two villages are selected from each district. Presently data is collected from 1181 villages. Number of items for price data collection is identified through the market survey and it is around 225. Price data is collected from selected shops in the villages every month by the Department of Posts.
2. For CPI (Urban), data is collected from all cities, having a population of more than 9 lakhs. Presently, total number of selected cities is 310. Number of items for price data collection is identified through the market survey and it is around 250. Each selected market is visited every month for price data collection from shops and outlets.
3. 4.75 lakh price data records collected from rural and urban areas are uploaded per month to the web portal of National Informatics Centre, which is the formal data collection arm of NSSO (National Sample Survey Organisation).

Although computation of index number is quite simple while using this method, yet it is not ordinarily used because of the following limitations:

1. All items are given equal weightage.
2. This measure of index number is influenced by the items which are highly priced.
3. This method is affected with the change in the unit of measurement. For example, index number computed when price of wheat is expressed in per kg, will be different from the index number computed when the price of wheat is expressed in per quintal.

The base period (base year) is the reference period with which current period (current year) is compared. The selection of the base period is essential while preparing an index number.
Desirable Properties of the Base year: The following are the basic properties (or considerations) underlying the selection of base year:

1. The base year should be a normal year. It should be free from all sorts of abnormalities or irregular fluctuations. Abnormal year like period of wars, floods etc. should not be selected as the base year.
2. The base year should neither be too near nor too far.
3. The base year should not be a year of distant past. It should be a year of recent past.
4. The base year should not be the period for which actual data is not available.

The four uses of Consumer Price Index Numbers are:

1. It is helpful in wage negotiation.
2. It is helpful in the formulation of general economic policy, as it is considered to be appropriate indicator of general inflation, which shows the most accurate impact of price rise on the cost of living of common people.
3. It is used by business units and government to regulate the dearness allowance to the employees in order to compensate them for the rising cost of living, on account of price rise.
4. It is helpful in analysing markets for particular kind of goods and services.

There are two methods of assigning weights:

1. Implicit weighting.
2. Explicit weighting.

In implicit weighting, a commodity or its variety is included in the index a number of times. For example if wheat is to be given in an index twice as much times as rice then the weight of wheat is two whereas in explicit weighting two types of weights can be assigned. i.e. quantity weights or value weights.
A quantity weight symbolized by q means the amount of commodity produced, distributed or consumed in some time period. A value weight in the other hand combines price with quantity produced, distributed or consumed and is denoted by v = pq. For example quantity weights are used in the method of weighted aggregative like Lasperey's, Paasche's index numbers and value weights are used in the method of weighted average of price relatives.

The following are the main steps in constructing a cost of living index number:

1. Decision about the class of people for whom the index is meant: It is absolutely essential to decide clearly the class of people for whom the index is meant i.e. whether it relates to industrial workers, teachers, officers, labors, etc. Along with the class of people it is also necessary to decide the geographical area covered by the index, such as a city, or an industrial area or a particular locality in a city.
2. Conducting family budget enquiry: Once the scope of the index is clearly defined the next step is to conduct a sample family budget enquiry i.e. we select a sample of families from the class of people for whom the index is intended and scrutinize their budgets in detail. The enquiry should be conducted during a normal period i.e. a period free from economic booms or depressions. The purpose of the enquiry is to determine the amount; an average family spends on different items. The family budget enquiry gives information about the nature and quality of the commodities consumed by the people.
3. Collecting retail prices of different commodities: The collection of retail prices is a very important and at the same time very difficult task, because such prices may vary from lace to place, shop to shop and person to person. Price quotations should be obtained from the local markets, where the class of people reside or from super bazaars or departmental stores from which they usually make their purchases.

The following items constitute the total consumption needs of our family:

1. Food.
2. Clothing.
3. Electricity.
4. House Rent.
5. Transportation.
6. Entertainment and Recreation.
7. Education.
8. Miscellaneous expenses.

A weighted index is preferred to unweighted because:

1. It gives different weights to different items as per their importance.
2. Its results are more reliable.
3. It is more accurate and useful.

Fisher's method is considered as an ideal method because:

1. It is based on variable weights.
2. It takes into consideration the price and quantities of both current year and base year.
3. It is based on geometric mean which is regarded online as the best mean for calculating index number.

Uses of index number are:

1. Index numbers are helpful in measuring the purchasing power i.e., value of the money.
2. These numbers are used to measure level of economic activities like import, export, production, population, etc.)
3. These numbers are helpful in evaluating economic policy e.g., index number helps in knowing the effect of export policy on export.

1. Errors may occur in the construction because of inaccurate specification of groups for whom the index is meant.
2. Faulty selection of representative commodities resulting out of unscientific family budget enquiries.
3. Inadequate and unrepresentative nature of price quotations and use of inaccurate weights.
4. Frequent changes in demand and prices of the commodity. The average family might not be always a representative one.

Index numbers are statistical devices designed to measure the relative change in the level of variable or group of variables with respect to time, geographical location etc.
In other words these are the numbers which express the value of a variable at any given period called "current period "as a percentage of the value of that variable at some standard period called "base period”.
Following are the main uses of index number:

1. A Barometer: Index numbers serve as a barometer for measuring the value of money. With the help of index number we can easily make a comparison in the value of money in different years.
2. Importance For The Government: The change in the value of money has a direct effect on the public. So Govt. adopts the fiscal and monetary policy according the results of index numbers.
3. Throws Light On Economic Condition: Index numbers are very helpful in comparing the economic conditions of a particular group at two different periods.
4. Consumption Standard: If we want to know the true consumption standard of a class in a locality we can compute the consumption index number.