Issues in the Construction of an Index Number

Constructing a sound index number requires care on several points:

• Purpose. Be clear what the index is for — a volume index will not do when a value index is needed.
• Selection of items. Items are not equally important to every group of consumers; a petrol-price rise, for instance, may barely touch poor agricultural labourers. Items must be chosen to be as representative as possible so the index gives a meaningful picture.
• Base year. Every index needs one, and it should be as normal as possible — never a year of extreme values, and not too far in the past (comparing 1993 with 2005 is more meaningful than 1960 with 2005, since many 1960 basket items have disappeared). The base year is therefore updated routinely.
• Choice of formula. This depends on the question being studied; recall that Laspeyre's and Paasche's indices differ only in the weights they use.
• Reliability of data. Sources vary in reliability, and poor data give misleading results. Collect data carefully; when using secondary data, choose the most reliable source.