Index numbers possess much practical importance in measuring changes in the cost of living, production trends, trade, income variations, etc.
- In Measuring Changes in the Value of Money:
Index numbers are used to measure changes in the value of money. A study of the rise or fall in the value of money is essential for determining the direction of production and employment to facilitate future payments and to know changes in the real income of different groups of people at different places and times. As pointed out by Crowther, “By using the technical device of an index number, it is thus possible to measure changes in different aspects of the value of money, each particular aspect being relevant to a different purpose.”
- In Cost of Living:
Cost of living index numbers in the case of different groups of workers throw light on the rise or fall in the real income of workers. It is on the basis of the study of the cost of living index that money wages are determined and dearness and other allowances are granted to workers. The cost of living index is also the basis of wage negotiations and wage contracts.
- In Analysing Markets for Goods and Services:
Consumer price index numbers are used in analysing markets for particular kinds of goods and services. The weights assigned to different commodities like food, clothing, fuel, and lighting, house rent, etc., govern the market for such goods and services.
- In Measuring Changes in Industrial Production:
Index numbers of industrial production measure increase or decrease in industrial production in a given year as compared to the base year. We can know from such as index number the actual condition of different industries, whether production is increasing or decreasing in them, for an industrial index number measures changes in the quantity of production.
- In Internal Trade:
The study of indices of the wholesale prices of consumer and industrial goods and of industrial production helps commerce and industry in expanding or decreasing internal trade.
- In External Trade:
The foreign trade position of a country can be accessed on the basis of its export and import indices. These indices reveal whether the external trade of the country is increasing or decreasing.
- In Economic Policies:
Index numbers are helpful to the state in formulating and adopting appropriate economic policies. Index numbers measure changes in such magnitudes as prices, incomes, wages, production, employment, products, exports, imports, etc. By comparing the index numbers of these magnitudes for different periods, the government can know the present trend of economic activity and accordingly adopt price policy, foreign trade policy and general economic policies.
- In Determining the Foreign Exchange Rate:
Index numbers of wholesale price of two countries are used to determine their rate of foreign exchange. They are the basis of the purchasing power parity theory which determines the exchange rate between two countries on inconvertible paper standard.