Explain the significance of index numbers in economics.
An index number is a statistical measure designed to show changes in a variable or group of related variables with reference to time, geographical location, and other characteristics such as income, profession, etc. Index numbers are indispensable tools of economic analysis.
The significance of index numbers is as follows:
- Framing suitable policies: Index numbers provide guidelines to policymakers in framing suitable economic policies such as agricultural policy, industrial policy, fixation of wages, and dearness allowances in accordance with the cost of living, etc.
- Studies trends and tendencies: Index numbers are widely used to measure changes in economic variables such as production, prices, exports, imports, etc. over a period of time.
- Forecasting about the future economic activity: Index numbers are useful for making predictions for the future based on the analysis of the past and present trends in the economic activities. For example, based on the available data pertaining to imports and exports, future predictions can be made. Thus, forecasting guides in proper decision making.
- Measurement of inflation: Index numbers are also used to measure changes in the price level from time to time. It enables the government to undertake appropriate anti-inflationary measures. There is a legal provision to pay the D.A. (dearness allowance) to the employees in organised sector on the basis of changes in the Dearness Index.
- Useful to present financial data in real terms: Deflating means to make adjustments in the original data. Index numbers are used to adjust price changes, wage changes, etc. Thus, deflating helps to present financial data in real terms (at constant prices).