Steps involved in the construction of index numbers are as follows:
- Purpose of an Index Number : Before constructing an index number, one must know the purpose for which the index number is constructed. E.g. for the whole c sale price or retail price or for agricultural output, etc.
- Selection of a Base Year : It is important to select a base year against which comparisons are made. So base year or reference year should be a recent year and not a distant past. it should be normal and free from natural calamities, war, etc.
- Selection of Commodities: When the cost c of living index number of the middle class families is to be constructed, the items that are used by middle class families in everyday life should be included and items like big cars, AC’s, etc. should not be included.
- Selection of Prices : Prices differ from city ‘I to city and even from shop to shop in the same city. Hence, we should take a few standard shops from where middle class families buy goods and take the average of the prices of goods sold by them. Otherwise index number constructed may be misleading.
- Selection of suitable Average : An ; index number is a special kind of average, Generally arithmetic mean is commonly ? used for construction of index number as it is simple to calculate.
- Selection of Formula : Number of formulae can be used for construction, of index numbers. Economists have to decide which formula to use for the construction of a particular index number.
- Assigning proper Weights : Weights refer to the relative importance of different items in the construction of an index number. Weights may either be quantity weights (q) or value weights (p). All weights may not be equally important. Therefore, by s assigning specific weights better result can be obtained.
