Research & Analysis
In economics and finance, an index is a statistical measure of change in a representative group of individual data points. These data may be derived from any number of sources, including company performance, prices, productivity, and employment. Economic indices track economic health from different perspectives. Influential global financial indices such as the Global Dow, and the NASDAQ Composite track the performance of selected large and powerful companies in order to evaluate and predict economic trends. The Dow Jones Industrial Average and the S&P 500 primarily track U.S. markets, though some legacy international companies are included. The consumer price index tracks the variation in prices for different consumer goods and services over time in a constant geographical location, and is integral to calculations used to adjust salaries, bond interest rates, and tax thresholds for inflation. The GDP Deflator Index, or real GDP, measures the level of prices of all new, domestically produced, final goods and services in an economy. Market performance indices include the labour market index/job index and proprietary stock market index investment instruments offered by brokerage houses.
Some indices display market variations that cannot be captured in other ways. For example, the Economist provides a Big Mac Index that expresses the adjusted cost of a globally ubiquitous Big Mac as a percentage over or under the cost of a Big Mac in the U.S. in USD (estimated: $3.57). The least relatively expensive Big Mac price occurs in Hong Kong, at a 52% reduction from U.S. prices, or $1.71 U.S. Such indices can be used to help forecast currency values. From this example, it would be assumed that Hong Kong currency is undervalued, and provides a currency investment opportunity.
An index number is an economic data figure reflecting price or quantity compared with a standard or base value. The base usually equals 100 and the index number is usually expressed as 100 times the ratio to the base value. For example, if a commodity costs twice as much in 1970 as it did in 1960, its index number would be 200 relative to 1960. Index numbers are used especially to compare business activity, the cost of living, and employment. They enable economists to reduce unwieldy business data into easily understood terms.
In economics, index numbers generally are time series summarising movements in a group of related variables. In some cases, however, index numbers may compare geographic areas at a point in time. An example is a country's purchasing power parity. The best-known index number is the consumer price index, which measures changes in retail prices paid by consumers. In addition, a cost-of-living index (COLI) is a price index number that measures relative cost of living over time. In contrast to a COLI based on the true but unknown utility function, a superlative index number is an index number that can be calculated. Thus, superlative index numbers are used to provide a fairly close approximation to the underlying cost-of-living index number in a wide range of circumstances.
There is a substantial body of economic analysis concerning the construction of index numbers, desirable properties of index numbers and the relationship between index numbers and economic theory.
A number indicating change in magnitude, as of price, wage, employment, or production shifts, relative to the magnitude at a specified point usually taken as 100.
Index number problem
The "index number problem" is the construction of a valid index when both price and quantity change over time. For instance, in the construction of price indices for inflation, the nature of goods in the economy changes over time as well as their prices. A price index constructed in 1950 using a standard basket of goods based on 1950 consumption would not well represent the prices faced by consumers in 2000, as goods in some categories are no longer traded in 2000, new categories of goods have been introduced, and the relative spending on different categories of goods will change drastically. Furthermore, the goods in the basket may have changed in quality.
There is no theoretically ideal solution to this problem. In practice for retail price indices, the "basket of goods" is updated incrementally every few years to reflect changes. Nevertheless, the fact remains that many economic indices taken over the long term are not really like-for-like comparisons and this is an issue taken into account by researchers in economic history.