Construction of an Index Number:
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(a) Concept of price relative
Simplest example of an index number is price relative. It is defined as a ratio of price of a single commodity in a given period is called current period to its price in some past period is called base or reference period.
Price Relative (PR)
Example: In 1990 a loaf of bread was being sold at Rs. 2. But in 1998 the consumers had to pay Rs. 10 for the same bread. By how much the bread had become costlier in 1998?
Solution:
Base year price
Current year price
Price relative
(b) Concept of weights
There are two types of index number such as simple and weighted. Weight represent importance of different items in relation to each other.

Simple index number are index numbers with equal weights.

Weighted index numbers are with unequal weights.
Construction of simple index number
There are two methods of constructing simple index numbers:
(a) Simple aggregate method
(b) Simple average of price relative method
Example: The price of three commodities A, B and C increased from Rs. 50, 7 and 3 in 1997 to Rs. 52, 8 and 5 respectively in 1998. Find how much on an average price have increased?
(a) Simple aggregate method
Equal weight are given.
Steps:
1. Find the sum of current year prices of all items included in list
2. Find the sum of base year prices of the same items
3. Use the formula:
Solution:
Commodity  Price in 1997  Price in 1998 
A  50  52 
B  7  8 
C  3  5 

 
 
Price increase in one year 
(b) Simple average of price relative method
Steps:
1. Find % price relative for each commodity
2. Find sum of these % price relative
3. Divide by number of commodities included in the list.
Formula:
Solution:
Sr. No.  Commodities  Price (in Rs.)  Price relative (PR)  
1997  1998  
1  A  50  52 

2  B  7  8 

3  C  3  5 

N 
 
