Question

State how base year is selected in constructing an index number

Answer 1

THE CONSTRUCTION OF INDEX NUMBER :-
Construction of index number is a complicated process. The main steps for the construction of index number are following :

1. Purpose Of Index Number :-
If we do not have any purpose in mind, the selection of commodities, selection of markets and relation of base period is useless. So first of all we will have to fix the object of index number.

2. Selection Of Commodities :-
For the construction of index number it is necessary to include only these commodities which are most commonly used by that class of people for whom, the index number are constructed. For example poor class uses vegetables, so we will have to select this at the time of construction.

3. Selection Of Markets :-
If we want to construct the cost of living index number of rich class, then we will have to choose those markets where this class goes for shopping.

4. Price Quotations :-
The prices of commodities vary from place to place and from shop to shop in the same locality. It is not possible to collect prices from cash and every shop in the selected market but we should take into account the whole sale prices and not the retail prices.

5. Choice Of Base Period :-
There are two methods for selecting the base period. One method is the selection of certain year as a base year. While the other is chain base method. Some times a normal year prices are neither too high nor too low as compared to the previous years.

Fixed Base Method Formula = Price for the current year/ Price for the base year x 100

Chain Base Method = Price in the current year/ Price of the previous year x 100

6. Choice Of The Average :-
After computing the link relative, their average is taken to get the required index number. The average in the base year will be always 100. If average in the subsequent year is high indicates the rise in the general price level otherwise it will show fall in the price level.

7. Choice Of Weight :-
While constructing index number proper weights are given according the importance of different commodities. More important commodity will get more weight. Because of a rise in the prices of essential commodities the poor consumer is more affected then others.
Following are the methods which are generally :

1. Weighted aggregate method.
2. Weighted average of relatives.

8. Average Of Price Ratio :-
An average of the prices of the commodities can be calculated in many ways. Usually Arithmetic mean and Geometric mean is used.

The following table shows that how an index number is constructed.

Formula P/PO x 100 = PO = Price of Current Year = Price of the base year.

Hope it will help you!!