Uses of Index Numbers

Practically, in all areas of economic activity, changes are measured using index numbers. It helps in recording changes in output, income, employment, business activities, productivity, etc.

According to M.M. Blair “Index numbers are the signs and guide posts along the business highway that indicate to the businessman how he should drive or manage affairs.

1. Measurement and Comparison of Changes in the Price Level:

It is not possible to measure changes in the price level of two variables in absolute terms; therefore, index numbers provide a relative measure to the changes in the magnitude of a group of variables. It can be used to know the influence of changes in the value of money on different sections of society. It is possible to solve the problem of inflation or deflation in the system.

2. Helps in Policy Formulation:

An index number is an important tool for government or non-government organizations in the following ways:

• In policy formulation, there is a need for a base or trend. With the index numbers, the trends of different phenomena can be studied.
• It can also be utilized in the formulation and planning of government and business policies.

3. Acts as an Economic Barometer:

A barometer is an instrument that is used to measure atmospheric pressure. It indicates fluctuations in the general conditions of a country and measures the pulse of the economy.

4. Helps in Studying Trade:

Index numbers are useful in studying the trend of a series over a period of time. It helps in forecasting future trends which is crucial for any business or production activity’s future operations. Besides, it also aids in determining patterns in exports, imports, prices, and several other occurrences. For example, If someone is planning on opening up a new business, then by studying the trend of price, wages, income, etc., in different industries will help the businessman in planning the future course of action for the business.

5. Measure Purchasing Power:

Money’s worth is determined by purchasing power, and purchasing power is determined by commodity prices. Index numbers help find the intrinsic value of money as contrasted with its nominal value. It helps in establishing the nation’s wage policy. Besides, a change in the price of the commodity adversely affects the value of money. When the price level of a commodity rises, the purchasing power or value of money falls. 

6. Helps in Deflating Various Values:

With price index numbers, it becomes easy to adjust the monetary figures of the different periods for changes in the price. For example, a country’s national income is calculated on the basis of the prices of the year mentioned in the question. However, the real change in the production level of goods and services cannot be revealed through the national income computed at the current year’s price. To know the real change, first, we have to adjust the figures for the price changes in different years. Making adjustments is possible only by using price index numbers. Besides, in case of rise in prices, the process of adjustment is known as deflating.