Copyright 2010, The World Bank Group. All Rights Reserved. Producer prices, part 1 Introduction Business Statistics and Registers 1

Copyright 2010, The World Bank Group. All Rights Reserved. Concepts A Producer Price Index (PPI) provides a weighted average of the price changes in a group of products between one time period and another For an index to provide information on price changes, at least two index numbers from the same series need to be available, and these index numbers must relate to the same basket of goods There is no unique PPI, since the prices of different combinations of goods and services do not all change at the same rate Because price changes can vary considerably from product to product, the value of the price index will be dependent on the precise set of goods and services selected 2

Copyright 2010, The World Bank Group. All Rights Reserved. Use of PPI The PPI has the following main uses: 1 Indexation of contracts 2 National accounts deflators 3 Short-term indicator of inflationary trends 3

Copyright 2010, The World Bank Group. All Rights Reserved. Indexation of contracts Indexation of contracts involves adjustment to the value of monetary amounts based on the increase or decrease in the level of a price index to take the inflationary risk out of the contract Indexation n is common in long-term contracts, e.g. in construction and aircraft production It is important that parties understand the exact makeup of the index to ensure that it is suitable for the purpose 4

Copyright 2010, The World Bank Group. All Rights Reserved. National accounts deflator A vital use of the PPIs is as a deflator of production volumes in the national accounts For deflation of national accounts, current- weighted indices and fine aggregations are required Paasche price indices would be ideal Many countries use chain-linked indices as an alternative 5

Copyright 2010, The World Bank Group. All Rights Reserved. Basic price and producer price The basic price is the amount receivable by the producer from the purchaser for a unit of a good or service Basic prices are output minus any tax payable, and plus any subsidy receivable, and exclude any transport charges invoiced separately The producer’s price is the amount receivable by the producer from the purchaser for a unit of a good or service, minus any VAT or similar deductible tax, invoiced to the purchaser, and excluding transport charges The difference between basic and producer prices is generally the per unit subsidy that the producer receives and taxes on production Basic prices are preferred in the PPI In most cases basic and producer prices will be the same 6

Copyright 2010, The World Bank Group. All Rights Reserved. Short term inflation indicator Monthly or quarterly PPI with detailed product and industry data allows short-term price inflation to be monitored Models analyze price pressures that different sectors of the economy are facing 7

Copyright 2010, The World Bank Group. All Rights Reserved. Inflationary pressures - as inputs into the production process - and as outputs produced by the production process Prices for the PPI can be measured at two points: - input prices - and output prices Therefore, the PPI can be split into two key groups: 8

Copyright 2010, The World Bank Group. All Rights Reserved. Output prices Output prices are the basic prices received by the producer An output price index measures the average price change of all covered goods and services resulting from an activity PPI prices should be actual transaction prices, which can be directly recorded The price should be recorded at the time when the transaction occurs Intercompany transfer prices should be used with caution 9

Copyright 2010, The World Bank Group. All Rights Reserved. Input prices Input price indices measure the change in the prices of all intermediate inputs used in production An input PPI measures changes in the cost of the basket of purchases required as inputs into the production process, excluding primary inputs like land, labor, or capital 10

Copyright 2010, The World Bank Group. All Rights Reserved. Export/import prices Export and import prices are an important extension of domestic PPIs They are used in the deflation of external trade Import prices feed into the producer input index, since these are an important contribution to producer costs It is difficult to collect these price data from establishments Price and quantity data on imports and exports are therefore collected by other surveys 11

Copyright 2010, The World Bank Group. All Rights Reserved. Wholesale prices The Wholesale Prince Index (WPI) is the precursor of the PPI The WPI was a measure of price changes one stage prior to final demand The WPI differs from the PPI because it includes both domestically produced products and imported products (excluded from the PPI), while excluding prices of exported products 12

Copyright 2010, The World Bank Group. All Rights Reserved. Taxes Taxes on products are generally excluded from PPIs because these are usually deductible as an expense by businesses Taxes such as excise duty on imports are sometimes included Change in taxes may change prices It is possible to produce ex-tax/ex-duty indices 13

Copyright 2010, The World Bank Group. All Rights Reserved. Coverage Most PPIs measure price change for the goods producing sectors of the domestic economy, includ. agriculture, forestry, and fishing; mining; manufacturing; and public utilities The construction sector has generally not been considered a component of the traditional goods-based PPI The services sectors that are in scope for a PPI vary across countries Many countries are interested in creating a corporate services price index A more expansive definition could include all services transactions that are in intermediate demand 14

Copyright 2010, The World Bank Group. All Rights Reserved. Price coverage The appropriate price to obtain from a theoretical perspective should be the price at the time there is a change in ownership It is difficult to adhere to this in practice Therefore, shipment price are often used In most circumstances the shipment price is final at the time of delivery to the customer 15

Copyright 2010, The World Bank Group. All Rights Reserved. Net transaction prices Net transaction prices are actual shipment prices received by the producer for the sales transaction The price includes the impact of all discounts, surcharges, rebates, etc. for a unique customer or unique class of customer Different types of prices meet the definition of the net transaction price closely: particularly order prices 16

Copyright 2010, The World Bank Group. All Rights Reserved. Order prices Order prices refer to the price quoted at the time the customer places an order There usually will not be any difference between order and shipment prices For goods with an extended production process other solutions must be used 17

Copyright 2010, The World Bank Group. All Rights Reserved. Role of weights The PPI is calculated from many prices collected from all types of establishments The collected prices are first combined to compile indices for each individual product Because some products have greater production or sales than others, each product is given a weight to represent its importance in total output or sales To arrive at the aggregate index figure, the price relatives of the individual products are multiplied by these weights to derive a weighted average aggregate index Weights are key elements in the construction of a PPI 18

Copyright 2010, The World Bank Group. All Rights Reserved. Value weights The best approach would be to have value of production weights at basic prices for all levels of index aggregation Since the PPI can also be used to measure the change in intermediate input prices, the value weights for the input index would be the cost of the input products to the producer The value weight multiplied by the long-term price relative provides the estimate of what it would cost at today’s prices to produce the quantity of product in the price reference period. 19

Copyright 2010, The World Bank Group. All Rights Reserved. Quantity weights The use of quantity weights is appropriate as long as the same specific product was produced as in the base period, that is, there is no qualitative difference between the current product produced and the base-period product Quantity weights are feasible only at the detailed product level At higher levels of aggregation, such as at the product group level or industry level, a value aggregate is more appropriate 20

Copyright 2010, The World Bank Group. All Rights Reserved. Classification of goods The classification scheme of goods and services in the PPI should follow the Central Product Classification In terms of economic activities, the establishments should be classified using ISIC, Revision 4 21