PRODUCER PRICE INDEX
A variety of the goods are selected and the prices of the respective goods are then gathered each month. The change in the price of the respective goods is then weighted to mirror the relative importance of the goods in the current year. These values are then added for different sectors to give the required index. This is the concept behind the producer price index.
The Producer Price Index release usually shows the index figures for three different goods Crude, Intermediate and Finished (Barnes, 2010).
PPI Commodity Index (Crude) It measures the change in the selling prices of the producers for products such as energy, crude oil and coal.
PPI Stage of Processing (SOP) Index (Intermediate) It measures the change in the selling prices of the producers for commodities that have are semi-processed and have been passed along to another producer for further value addition. It includes goods such as cotton, steel and diesel fuel.
PPI Industry Index (Finished) It measures the change in the selling prices of the producers for the finished goods and forms the basis of the core PPI. This figure is usually considered to be the most significant for its greater relation to the state of economy. It is calculated as the finished goods index less the food and energy component indexes. This is because these components are considered to be volatile and mislead the real PPI figure.
The movements in this index are interpreted with respect to a base year which is usually awarded the base level of 100. A PPI index of 120 would be interpreted as an increase of 20 in the prices of the commodities whereas a PPI index of 70 would mean a 30 decrease in the prices of the commodities since the base year.
With the help of the producer price index, the investors are able to predict the consumer price index. This is because the cost increases are most of the time passes along to the consumers. Therefore, the price change at the PPI level would greatly help in estimating the price change at the consumer front. At the same time, the governments can use the PPI figures to develop the policies to combat inflation in the nation. It can also use to predict the GDP deflator (Barnes, 2010).
PPI, at the same time, has some major limitations. It does not include all types of goods and services being produced in the economy. There are some forms of industries that are incorporated in this index and hence, the index does not reflect on the whole economy. This type of index can be distorted by the inclusion of more volatile industries such as crude oil and energy. Therefore, it is a biased index to some extent (Barnes, 2010).
DIFFERENCE BETWEEN CPI AND PPI
PPI measures the change in the price level from the sellers point of view whereas the CPI measures the change in the price level from the perspective of the buyer. This is basic difference between the two indexes.
Both the indexes, PPI and CPI, determine the price changes over the time for products and services, but they differ at two important fronts. One is the type of the products and services included in each index and the other is the nature of the prices collected for the respective goods and services.
The composition of the PPI includes all types of goods and services produced in the country. It includes the semi-processed goods that serve as an input to other producers or as capital investments as well as all the finished goods produced locally. This index does not include the imports of the country since they are not locally produced. On the other hand, the CPI includes all the goods and services that are bought to be consumed by the respective countrys households. Therefore, it also includes the imports that are being consumed or used (BLS, 2009).
In the PPI measure, the income received by the producers in taken into account. Hence, it does not include the sales and excise taxes that are added after the production. On the other hand, the CPI includes the price paid by the consumers directly. Therefore, it includes the sales and excise taxes paid the households as well (BLS, 2009).
MONITORING OF PPI BY THE GOVERNMENT
The indexes are important measures for all the governments to develop future policies and strategies for the country. It allows them to separate the change caused by the greater production of goods and services from the change caused by the higher prices. The increase in production of the commodities is beneficial for the economy and leads to a better standards of living. On the other hand, the increase due to prices is not beneficial but leads to inflation in the economy. Hence, it results in a lower standard of living and less economic activity.
The producer price index reflects on the cost of production of goods and services. An increase this index is likely to cause an increase in the retail prices across the nation. Hence, studying this index forewarns the government of the resulting inflation and allows them to develop strategies to combat this surge in prices. At the same time, monitoring the PPI will help the government to develop policies for financially supporting the business with increasing cost of production through subsidies, grants, tax concession and other funding.
My Government currently monitors the PPI for the following purposes
Observes and measures the inflation rate for the manufacturing sectors within the economy during different stages.
Uses it as a deflator to change the values of major economic indicators to constant prices.
CPI AND GDP DEFLATOR
The consumer price index is a measure that reflects on the changes in the prices of the fixed basket of the goods and services including housing, electricity and food. In the case of Consumer Price Index, the movements of this index from one date to other measures the relative change in the price level. With the reference date index at 100, an index of 110 at later date would be interpreted as a 10 increase in the price of the respective basket of goods and services. On the other hand, the GDP deflator mirrors the average level of price prevalent in the current economic system. At the same time, the measure also indicates the level of economic activity in the country (Samuelson, 1998).
The GDP deflator appears to be more accurate and precise measure for the inflation rates and other macroeconomic indicators. Hence, the economists and the market analysts prefer it over the CPI based inflation rates.
Both the CPI and the GDP deflator estimate the rate of inflation. The GDP deflator considers the unlimited amount of substitution of the more expensive good with the less expensive goods so it underestimates the rate of inflation. On the other hand, the CPI considers zero substitution and hence overestimates the rate of inflation. Therefore, both are imprecise estimators of inflation. (Samuelson, 1998).
CPI and GDP deflator both estimate the rate of inflation with the same preciseness. But there is slight difference between the measures of the inflation and their abilities. The CPI uses a fixed basket of goods. In this case, the quantities of the goods consumed in the two years being compared remains the same whereas the prices of these commodities changes. On the other hand, in GDP deflator the prices of the commodities remain the same in the two years being compared while the quantities and the basket of goods are flexible. In this case, the basket changes with the changes in the consumption and the investment patterns of the people of the country (Samuelson. 1998).
At the same time, the CPI mirrors the prices of the basket of goods that represents the purchases of the consumers whereas GDP deflator imitates the prices of all the goods that are produced locally.