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Limitations of Index Numbers

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notes

Limitations of index numbers : 
Index numbers are useful in practice. However they suffer from certain limitations. Therefore, they are not completely reliable.
1) Based on samples :
Index numbers are generally based on samples. We cannot include all the items in the construction of the index numbers. Hence they are not free from sampling errors.
2) Bias in the data :
Index numbers are constructed on the basis of various types of data which may be incomplete. There may be bias in the data collected. This is bound to affect the results of the index numbers.
3) Misuse of Index Numbers :
Index numbers can be misused. They compare a situation in the current year with a situation in the base year. Hence a person may choose a base year which will be suitable for his purpose. For example, a businessman may choose a year in which his profit is high as the base year and show that his profit is falling in the current years.
4) Defects in formulae :
There is no perfect formula for the construction of an index number. It is only an average and so it has all the limitations of an average.
5) Changes in the economy :
The habits, tastes and expectations of the people in a country are always changing and all these changes cannot be included in the estimation of index numbers.
6) Qualitative changes :
The price or quantity index numbers may ignore the changes in qualities of the products. At any given time, a better quality commodity will have a higher production cost and a higher price than an ordinary commodity which is a substitute for the better product.
7) Arbitrary weights :
The weights assigned to different commodities may be arbitrary.
8) Limited scope :
An index number has limited scope because if it is constructed for one purpose then it cannot be used for any other purpose. 

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