Index Numbers

How do we measure that "prices have risen" when thousands of goods change by different amounts — some up, some down? We use an index number: a statistical figure that shows the average change in a group of related values (such as prices or production) over time, compared with a chosen base year. The base year's value is always taken as 100, and other years are expressed in relation to it.

For example, if the price index for 2025 is 120 (base year 2020 = 100), it means prices on average are 20% higher than in 2020. Index numbers are often called economic barometers because they show the "weather" of the economy.

Uses of index numbers: they measure changes in the cost of living and in prices, help measure inflation, guide government policy (e.g. dearness allowance is linked to the price index), help compare economic conditions across time, and are used in business and trade.

The simplest way to build a price index is the simple aggregative method:

P₀₁ = (ΣP₁ ÷ ΣP₀) × 100

where ΣP₁ is the sum of current-year prices and ΣP₀ is the sum of base-year prices. For example, if a basket of goods cost ₹80 in the base year and ₹100 now, the index = (100 ÷ 80) × 100 = 125, showing a 25% rise. (A drawback is that it ignores the relative importance of items, which weighted methods correct.)

Different index numbers measure different things. The three most important in India are:

• Consumer Price Index (CPI) — measures the change in the retail prices of goods and services commonly bought by households. It is also called the cost-of-living index, because it tells how the cost of a typical family's shopping basket has changed. The CPI is the main measure used for the dearness allowance of workers and for everyday inflation.
• Wholesale Price Index (WPI) — measures the change in the wholesale prices of goods (prices at which goods are traded in bulk, before retail). It does not include services. The WPI is widely used to study price trends and inflation at the producer/trade level.
• Index of Industrial Production (IIP) — measures the change in the volume of industrial output (mining, manufacturing and electricity), not prices. A rising IIP shows the industrial sector is growing; a falling IIP signals a slowdown.

So CPI and WPI track prices (retail and wholesale), while the IIP tracks quantity of production. Each is published regularly by the government and is closely watched by policymakers, businesses and the public to judge the health of the economy.

One of the most important uses of index numbers is to measure inflation — a sustained rise in the general price level over time, which reduces the purchasing power of money (the same money buys fewer goods). Index numbers (CPI or WPI) are the tool that turns "prices feel high" into an exact figure.

The rate of inflation between two years is the percentage change in the price index:

Inflation rate = [(Index of current year − Index of previous year) ÷ Index of previous year] × 100

For example, if the CPI rises from 200 to 220 in a year, the inflation rate = [(220 − 200) ÷ 200] × 100 = (20 ÷ 200) × 100 = 10%. This means prices rose 10% over the year and money lost some of its value.

Why does this matter? High inflation hurts people on fixed incomes (their money buys less), discourages saving, and creates uncertainty; that is why governments and the Reserve Bank of India watch the price indices closely and act to keep inflation low and stable. When interpreting any index number, remember three cautions: the base year should be normal (not an unusual year), the items and weights should be representative, and an index shows an average change — individual prices may have moved quite differently. Used carefully, index numbers are among the most powerful tools in economic statistics.