4 Steps to Construct Index Numbers

Index number is a statistical measure of average change in a variable or a group of variables with respect to time or space. The variable may be the enrolment of staff in an organization, the cost of salaries for staff, prices of a particular commodity or a group of commodities, wages of workers, volume of trade, sales, exports and imports, production, etc.

Following are the four important steps to construct index numbers in statistics.

1. Selection of Commodities for Inclusion

The first step is to decide on the number of commodities to be included. There is no hard and fast rule for this purpose. Though in statistical theory there is a well recognized principle that the larger the number of items included, the greater would be the accuracy. However, a very large numbers of commodities would involve its own complication in addition to expense and delay in the construction. Hence a reasonable number of commodities on the bases of their importance should be used.

2. Selection of the Base Period

Base period is a period from which the changes are measured. The prices of all other periods are then expressed as percentages of the base period prices. Two method of selecting the base period 1) fixed base method, and 2) chain base method.

3. Selection of average:

We need to make the choice of an appropriate average to get a single index number for each year. One of following three averages can be used for this purpose:

  1. arithmetic mean
  2. median
  3. geometric mean

4. Selection of Appropriate Weights:

Since all the commodities selected are not equally important, in wholesale price index numbers it is important to decide how to select weights to indicate the relative importance of various commodities in each group. For example, fast foods and vegetables cannot be given the same importance as wheat and rice. Because wheat is much more important than fast foods, therefore it is desirable that wheat must be given more importance. To meet this requirement of taking into account the relative importance of each commodity, a sample survey may also be conducted. On the basis of this survey, each commodity should be assigned a multiplier (weight) to express its relative importance in the group.

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