Question

Explain any four limitations of an index number.

Answer 1

The limitations of index numbers are as follows:

1. Based on samples: Selected items, not the total population, are used to calculate index numbers. The index may produce incorrect results if the sample is not representative.
2. Bias in the data: Index figures are derived from a variety of data sources, some of which may be insufficient. The information gathered might be biased. This will undoubtedly have a negative impact on the index numbers' outcomes.
3. Misuse of index numbers: It is possible to abuse index numbers. They contrast the current year's circumstances with those of the base year. As a result, an individual can select a base year that best suits his needs. For example, we may obtain inaccurate results when examining employment trends if a year of drought or recession is chosen as the base year and the employment level in the current year is compared to the employment level in the base year.
4. Defects in formulae: There isn't a flawless formula for creating an index number. Since it is simply an average, it has all of the drawbacks of an average.