Explain the various Problems in Construction of Price Index Numbers.

Problems in the Construction of Index Numbers:

Selecting the purpose of the index number:

There cannot be any all-purpose index. For example, if an index number is to measure consumers prices, then it must not include or cover wholesale prices. If the purpose of the index number is not settled clearly, then it is bound to lead to nothing but chaos.

Selecting base period: 

In the construction of index numbers, a particular year is always taken as “Base Year” and all indices are expressed as a relation to this base year. Index number for the base period or year is always taken to be 100.

Selecting items: 

The items or data to form basis of index numbers, however, entirely depends on the purpose for which the index number is computed. Every item cannot be just included in the construction of the index numbers. For example, if an index number is being calculated for the working class, then commodities such as scooter, cars, T.Vs. etc. should not be included. Further, all commodities also can not be included.

Selecting price quotations : 

A wise selection has to be made of only representative prices.

Selecting an average: 

For the construction of index numbers, usually the choice lies between arithmetic mean and geometric mean alone as other measures of averages are rarely used. Even out of these two geometric mean should always be preferred. It is this average which satisfies the time reversal test.

Selecting appropriate formula: 

This choice first depends on the data available. An index number should be such which satisfies both Factor Reversal and Time Reversal Tests. As such, Fisher’s formula is the most ideal one.