What Difficulties Are Faced in Measuring the Changes in Value of Money?

To measure the changes in the value of money through relative price indices over a period of time is not an easy task. There are various difficulties to be encountered while doing so. These are generally; (i) conceptual difficulties; (ii) practical difficulties; and (iii) use difficulties.

Conceptual Difficulties:

Conceptually, the value of money being the reciprocal of the general price level, changes in the value of money are to be measured in terms of the changes in the general price level is, however, purely theoretical.

Its practical application is beset with difficulties. For instance, in theory the general price level implies inclusion of all prices, but we cannot, in practice, include all the individual prices in it.

Thus, the concept of general price level is too vague to be of any practical use. We then obviously have to resort to sectional price levels only.

But the different indices for different sectional average price levels, such as wholesale price indices, cost of living index number of the working class, middle class, etc. vary in magnitude at different times and in different places.

Hence, changes in the purchasing power of money differ accordingly and comparison becomes difficult.

In a strict sense, thus, the concept of general price level is theoretically inadmissible. It is scarcely observed that relative expenditures on different commodities remain the same from year to year; or that the content and quality of a commodity remain unchanged. To that extent obviously, the basis of comparison is vitiated.

Moreover, ordinarily changes in the value of money are preferably measured through wholesale price index numbers, but the masses are directly affected by retail price variations rather than by wholesale prices.

Another difficulty is that a change in the general level of prices is viewed only approximately. Thus, there may be individual cases where prices of some goods might not have changed to the extent as indicated by the general price indices.

Practical Difficulties:

As has been seen in the previous section, a number of practical problems have to be faced while constructing a price index number in order to measure the changes in the value of money.

Specific difficulties arise while collecting data. There may be heterogeneity of price quotations, lack of consonance between prices and quality of goods, changes in their qualities over a period of time, etc. which may puzzle the statistician in the right collection of data.

Indifferent attitude of the people, traders and consumers, their non-cooperation and lack of up-to-date records and improper accounts also pose serious difficulties. Paucity of trained staff may aggravate the problem further.

In view of these difficulties, Keynes remarked, “Hitherto no official authority has compiled an index number which could fairly be called an index number of purchasing power.”

Use Difficulties:

Apart from the practical problems involved in its construction, an index number also poses difficulties while using it for comparisons over time or place to measure the changes in the value of money.

(i) An index number constructed for one purpose may not be useful for another. Obviously, a comparison between a wholesale price index and the retail price index is not possible.

Similarly, the cost of living index number of textile workers cannot be used to measure changes in the value of money of the middle class group.

(ii)Owing to the differences in items, variations in qualities, and the relative price structure, and the differing base years, in the construction of price index numbers by the different countries, we cannot reliably use them to make international comparisons of changes in the value of money of the middle class group.

(iii) An index number being an average indicates general changes in the value of money on an average. Obviously, it cannot precisely deal with a particular individual’s money and changes in its purchasing power.

Thus, a particularly individual may not be affected by a rise or fall in the price level to the extent indicated by the index number.

(iv) Index numbers do not recognise dynamic changes of the economy.

(v) Owing to a number of practical difficulties, involved in their construction, index numbers are never exact with mathematical precision in measuring the changes in the value of money.

As a result of all these difficulties, the index number is seriously limited in its utility, i.e., in comparing the purchasing power of money, over time and space.

It is practically impossible to measure the actual extent of the changes in the prices and consequently, the changes in the value of money.

In the face of these difficulties and inaccuracies in its construction, the index number can simply be regarded as a mere approximation, indicating rising or falling trends.

In short, the index number is not a very satisfactory tool of measuring changes in value of money. The measurement of the changes in the value of money, between times and places, through index numbers can only give a rough, approximate idea of the changes in the value of money; that, too, will be arbitrary and inaccurate.