Index Number in Money

Value of money changes from time to time according to variation in prices of different commodities. All prices do not change in the same extend. Some may rise or fall of remain constant. The degree of changes in price may differ from commodity to commodity.
Index number is an instrument to measure change in value of money according to change in prices. Generally index number takes the from of table.
Types of Index Number:
In general there are two types of index number:
i) Simple Index Number
The index number is constructed by giving equal importance or weighted to all commodities is called simple index number. In the simple index number, we assume base year equal to 100. According to this method, price index number is the outcome of the sum of prices for the current year divided by the sum of actual prices for the base year.
ii) Weighted Index Number
The index number constructing by giving weighted to various items as per their importance is called as weighted index number. Simple index number just gives equal importance to all commodities. Since, weighted index number are constructed on the basis of importance of commodities to the people, it measures accurate change in the value of money. In this method, different weights are assigned to different items according to their relative economic importance. There are different formulae to calculate index number by assigning different weights to different commodities.

Importance of Index Number
i) Measurement of changes in cost of living
When a price of commodity goes up, cost of living rises. If prices fall cost of living also fall.
ii) Study of fluctuation
By index number we can measured the rate of inflation and deflation.
iii) Wage policy formulation
Government changes wage policy on the basis of index number. If price level rises then government increases the wage level.
iv) Government policy formulation
Government has to formulate monetary and fiscal from time to time on the basis of price level.
v) Business forecast
Business is a matter of forecast. Prices may rise or fall in future. On the basis of past and present facts the future expectation can be made on the basis of index number.

Difficulties in constructing Index Number
i) Selection base year
One should be serious while selecting base year for index number. It should be normal year. It should not be fluctuated by any abnormal factors such as war, flood, earthquake etc. It is difficult task to select such.
ii) Problem of weight
Taking appropriate weight from the selected commodities is another difficulty of constructing index number. There should be accuracy and reliability in measuring the standard of weight commodities.
iii) Collection of data
Another difficulty of constructing index number is collection of data from the representative commodities. It is also difficult to find the reliable and authentic source of data.