Under this method, the price index for a given period is obtained by dividing the aggregate of different prices of the current year by the aggregate of different prices of the base year, and multiplying the quotient by 100. As such, the price index, under this method, is computed by the formula,
P01 = ( ∑P1/∑P0 ) X 100
Where, P01 = Price index of the current year with reference to the base year
∑P1 = total of the prices of the current year
∑P0 = total of the prices of the base year.
The merits and demerits of this method can be outlined as under:
- It is very to understand.
- It is very simple calculate.
- It is affected by the magnitude of the prices of the different commodities.
- It is influenced by the units of the articles through which the prices are quoted.
- It is based on the assumption that the various items and their prices are expressed in the same unit.
- It ignores the relative importance of the different commodities included in the index number.
- It is not capable of being calculated through other averages viz. geometric mean, median etc. than the arithmetic mean only.