Uses of Index Numbers

Index numbers are indispensable tools of economic and business analysis. Their significance can be best appreciated by the following points:

(1)    They help in framing suitable policies.

Many of the economic and business policies are guided by index numbers. For example, while deciding the increase in dearness allowances of the employees, the employers have to depend primarily upon the cost of living index.

(2)    They reveal trends and tendencies.

Since index numbers are most widely used for measuring changes over a period of time the time series so formed enable us to study the general trend of the phenomenon under study. For example, by examining index number of imports for India for the last 8 – 10 years. By examining the trend of the phenomenon under study we can draw very important conclusion as to how much change is taking place due to the effect of seasonality, cyclical forces, irregular forces, etc. Thus index numbers are highly useful in studying the general business conditions.

(3)    Index numbers are very useful in deflating.

Index numbers are highly useful in deflating, i.e., they are used to adjust the original data for price changes, or to adjust wages for cost of living changes and thus transform nominal wages into real wages. Moreover, nominal income can be transformed into real income and nominal sales into real sales through appropriate index numbers.

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