The Theory of Index Numbers

The theory of index numbers has a long and distinguished history. The quantity theory of money asserts that the value of money, which in itself is a function of the general level of prices, varies with its supply. If the change in the money supply is followed by a proportionate change in all prices, then the measurement of the changes in the price level will not constitute any problem. Scholars like Edgeworth and Bowley were quick to recognize that the difficulties in quantifying fluctuations in purchasing power of money arose from the absence of such proportionality (Allen (1975, p.2)). As Frisch (1936, p.1) noted: