Under this method, an index number of prices for any given year is calculated after assigning the appropriate weights to the different items included in the index number. The weights to be assigned should be rational and relevant for the purpose. Such weights may be assigned on the basis of quantities, values, or sale price of the commodities consumed during the base year, or in some typical years. In this method, the index number is calculated by the following simple formula of weighted arithmetic average:
P01 = (∑p1W/ Po W) x 100
Where, P01 = Price index of the current year w.r.t the base year
∑p1W = Sum of the products of the price of the current year, and the respective weights of the items.
∑p0W = Sum of the products of the price of the base year and the respective weights of the items.
The chief merits of this method are as under:
- It is very simple to understand and easy to calculate.
- It reflects the relative importance of the various items included in the construction of the index number.
The chief demerits of this method are as follows:
- It does not permit the use of geometric mean which is considered as the most appropriate average for the index number.
- It leads to an arbitrary assignment of weights which fails to reflect the relative importance of the commodities.
- It does not make use of all the data that may be made available viz. p1,p0, q1 and q0.