Following are the steps/stages/principles/Fleads. involved:-
Purpose and the scope
Selection of base **
Selection of commodities or items
Obtaining price quotations
Choice of an average
Selection of weights
Selection of suitable formula
1. Purpose and scope:- At the very outset the purpose for which the index numbers is being constructed should be clearly defined. Since most of the latter problems will depend upon purpose, because the selection of items, base year, formulae will be different for different purposes. The purpose may be such as cost of living index number for urban areas, rural areas, factory workers etc. should be clearly defined. Also, it is necessary to state the scope of the index numbers such as, geographical region, time, Income etc.
2. Selection of the Base year: – Index numbers are always constructed with reference to some ** called base **. The ** may be a year, a month, week or a day. Following points are to be considered while selecting the base year.
The base ** selected should be Normal one, that is economically stable. It should be free from wars, floods, famine, booms, depressions, which affects the economic activities.
Also the base year selected should not be too long or too short distance. Since economic activities are always dynamic.
While selecting the base year, decision has to make whether fixed base or chain base year to be selected. In fixed base year, if the ** of comparison is kept fixed for all current years, it is called fixed-base **. Where as in chain base year, comparison is made always with the previous year.
3. Selection of items: – Items means sample of representative commodities/ items, required for day to day living, which are included in the construction of index number. According to the tastes, habits, customs and traditions etc., of working class people should be selected. It is also necessary to decide the grade or quality of items.
4. Obtaining price quotations: – After selecting the commodities/ items, the next problem is to fix the prices for the items selected. Since prices vary from place to place, and even from shop to shop in the same market. Hence the suitable way is to obtain the prices ascertained by Marketing inspectors, Super Bazaars, Co-operative Societies or took out the average prices collected by various shops or places where concerned.
5. Choice of an average:- Since index numbers are specialised averages so, in the construction of index numbers, suitable average should be used. The choice is made between Arithmetic mean and Geometric mean. Usually Arithmetic mean with weighted averages is popularly applied, but when accuracy is required Geometric mean is suitable.
6. Selection of Weights:- Weight of the items means, the relative importance of an items used in the construction of index number. Since all items are not equally important in day-today usage. Proper weights should be attached to the various items depending on their relative importance, eg: Sugar-Rice, Atta-Salt etc. Mostly these weights are quantities in the base ** or . those in the current ** are considered. Sometimes a combination of quantities of different time periods may be used as weights.
7. Selection of formula:- A large number of formulae have been devised for construction of Index numbers. Hence a reasonable formula/ method suitable to the object and the data available should be selected.
