Explanation:
Fisher’s Ideal Index is called ideal because it overcomes the bias of both Laspeyres’ (base year weighted) and Paasche’s (current year weighted) indices by taking their geometric mean, satisfying time reversal and factor reversal tests.
Time reversal test- An index number formula should give consistent results over time. If we reverse the time period (swap base year and current year), the product of the two index numbers should be 1 (or 100, depending on scale).
Mathematically:
P01×P10=1
where, P01= price index from time 0 to 1
P10= price index from time 1 back to 0
Interpretation:
If an index satisfies this test, it means it is time-consistent — the upward change going forward should be exactly offset by the backward change.
Which index passes?
Fisher’s Ideal Index satisfies the time reversal test, whereas Laspeyres’ and Paasche’s indices do not, due to their fixed weighting systems.
Factor reversal test- This test checks whether the price index multiplied by the quantity index equals the value index (i.e., the change in total monetary value from base period to current period).
Mathematically:
P01×Q01=V01
Interpretation:
If a formula passes this test, it means it measures price and quantity changes without leaving any part unexplained, perfectly decomposing the change in total value.
Which index passes?
Again, Fisher’s Ideal Index satisfies this test, while Laspeyres’ and Paasche’s indices do not.
Source: Statistics, HSC, Md. Abdul Aziz.
S.P. Gupta, Statistical Methods, 50th Edition, 2020
M.P. Gupta, Fundamentals of Statistics, 2018