Task 6 – Summary Document of Using Indexes

Indexation
Indexation is the procedure of changing an amount, wage, or other value based on changes in another pricing
or pricing index.
Indexation is a way to handle the effects of deflation, living expenses, or input prices over time, as well as
regional variances in costs and prices.
In inflationary circumstances, where failing to agree on consistent higher pay would result in continued actual
pay decreases for employees, indexation is frequently employed to increase wages.
Governments may also employ indexation to try and reduce the adverse consequences of deflation on receivers
of payment transfers and entitlements. Social Security payments, for example, are linked to the Consumer
Price Index's annual growth.
The Consumer Price Index (CPI) measures changes in the cost of commodities and services bought by
individuals for consumption. The CPI includes food, beverages, cigarettes, energy, accommodation, garments,
sleeping materials, and other items. The cost of the listed goods is gathered periodically for the index. The CPI
can also be used to assess the actual value of revenues, salaries, and pensions. The CPI is frequently used by
the RBI, which monitors price stability, as a macroeconomic indicator of inflation.
In 1947, the Office for National Statistics in the United Kingdom established the Retail Price Index (RPI) as an
indicator of deflation to analyze retail commodity and service costs. The UK government uses RPI for a wide
range of reasons, including evaluating the costs due on index-linked instruments (such as index-linked gilts)
and boosting social housing rent. RPI also considers residential expenses like mortgage payments on interest,
property assurance, and so on.
The index amounts for different ventures, assets, commodities, services, and wages are listed in an indexation
table. These values are displayed in a tabulated manner and span multiple years.
An example of an indexation table is shown below.
https://www.wallstreetmojo.com/wp-content/uploads/2020/03/Indexation-Table-and-Chart.jpg
The table above is the CPI of the US which varies every month.

An indexation graph represents the information contained in the indexation table. Economists and users use it
to rapidly assess the fluctuation of index values. Let's look at the graph for the previous example:

https://www.wallstreetmojo.com/wp-content/uploads/2022/01/Indexation-Chart.jpg

Valueof goods∈the given year

The formula is: × 100
Value of goods∈the base year

Advantages of Indexation
 1. It reduces investors' tax obligation by decreasing taxable revenue since the modified value of a
venture (which is normally more than the real purchase price) indicates smaller profits.
2. This strategy is used by firms to resolve wage disagreements among employees. Indexes standardize
pay, ensuring that workers receive fair earnings even during recessions.
3. Raw material cost indices are used by firms to standardize changes in raw material costs. This
ultimately aids in modifying the cost and selling price.
4. It even makes it easier to alter the pricing of two substitute commodities on the market.
5. With price indexation, the level of confidence among firms and customers is assessed.
6. It assists the government in determining the modifications in the value of commodities and services
owing to deflation—Consumer Price Index (CPI).
7. It is used to calculate the living costs for various communities.

Chain base relatives.

The previously explored index relatives that compare values with a defined period which are referred to as
fixed-base relatives. The examination of variations through time is known as chain base relative, and it is
utilized to construct an index set up on the previous period's cost.
There are steps in constructing chain base numbers. These include;
Value of current year
1. Calculate the link relatives by ×100 .
Price o fprevious year
Current year relative × previous year link relative
2. Calculate chain base by
100

Benefits of chain base relatives.

1. It enables the inclusion or introduction of newer products into the series, as well as the removal of
obsolete items.
2. Managers in a firm typically compare current times to the time right before it instead of any period of
the past. The base year in this system changes every year, making it more valuable to management.

Drawbacks of chain base relatives.

1. If figures for any of the years are not available, the chain index value for the next interval using this
method cannot be calculated. It's because calculating the connection relatives is required, which isn't
achievable for such a scenario.
2. When an inaccuracy arises during the computation of any of the link relatives, the inaccuracy is made
worse as all following link relatives be inaccurate as well. As a result, the entire series will provide an
inaccurate picture.
With the information provided by Company F, the indexation and chain base relative can be calculated. The
cost of commodities of the base year (2012) is 242.7 and the link relative to 2012 is assumed to be 100.
Year Indexation Link relative Chain base

2013 250.1 250.1 103.05× 100

×100=103.05 ×100=103.05 =103.05
242.7 242.7 100
2014 256.0 256.0 102.36× 103.05
×100=105.48 ×100=102.36 =105.48
242.7 250.1 100
 2015 258.5 258.5 100.98× 105.48
×100=106.51 ×100=100.98 =106.51
242.7 256.0 100
2016 263.1 263.1 101.78× 106.51
×100=108.41 ×100=101.78 =108.41
242.7 258.5 100
2017 272.57 272.57 103.60× 108.41
×100=112.31 ×100=103.60 =112.31
242.7 263.1 100

References.
THE INVESTOPEDIA TEAM (31 Oct 2021) Indexation Explained: Meaning and Examples [Online]:
https://www.investopedia.com/terms/i/indexation.asp
WALLSTREETMOJO TEAM: Indexation [Online]: https://www.wallstreetmojo.com/indexation/
Chain Index Numbers [Online]: https://www.toppr.com/guides/fundamentals-of-business-mathematics-and-
statistics/index-numbers/chain-index-numbers/
DIKSHA KENI: CPI vs RPI (Top Differences) [Online]: https://www.wallstreetmojo.com/cpi-vs-rpi/