What is Producer Price Index (PPI) and how does it work?

ECONOMICS

The Producer Price Index (PPI) also known as output price index measures the rate at which the prices of producing goods and services are changing over time. It is a key statistic for economic and business decision making and inflation monitoring. 

The PPI does not only serve as an early indicator of inflationary pressures in the economy before it reaches the consumer, but it can also record the evolution of prices over longer time periods.

BREAKING DOWN ‘Producer Price Index – PPI’

The PPI is interpreted in a similar way as most indexes. Each product or group of products starts with a base number of 100 with a base period. All future movements in producer prices are then measured against the prior period. Therefore, if a product has a base PPI of 100 and in the following month it has a PPI of 110, this indicates that the price of that product has increased by 10% compared to the previous period.

Industry-based Classification PPI

The PPI’s industry classification applies measures at the industry level and tracks the changes in prices received for an industry’s output outside the industry itself. This means that the PPI measures industry net output. The PPI publishes over 535 industry price indexes as well as over 4,000 product-related indexes and approximately 600 indexes that group industries together.

Commodity-Based Classification PPI

The PPI’s commodity classification organizes products and services by similarity and production composition and completely ignores the industry classification of the product being classified. There are more than 3,700 commodity price indexes published for goods and roughly 800 commodity price indexes published for services. These classifications are organized by product, service and end use.

Commodity-Based Final Demand-Intermediate Demand Classification PPI

The Commodity-Based Final Demand-Intermediate Demand (FD-ID) system is a new addition to the PPI, and it replaces the older stage-of-processing (SOP) system. The FD-ID system regroups commodity indexes for goods, services and construction into sub-product classes, which takes into account the specific buyer of the products and the amount of physical processing or assembly that the products have already undergone.

HOW PPI WORKS:

PPI is divided into three levels. The first is the PPI commodity index, which shows the average price change over a certain time period (usually a month) for commodities like crude oil and coal.

The second level is the PPI Stage Of Processing (SOP), which consists of goods that are in a manufacture stage between raw and finished, and will be sold to other manufacturers to create the finished goods. Examples include cotton, gasoline and steel.

The third and final PPI level consists of finished goods. That is, they have undergone their final stage of manufacturing and will be sold to consumers. The finished goods level is the source of the core PPI.

PPI of finished goods is a direct indicator of the near-term level of the Consumer Price Index. This is because changes in prices at the retail level (finished goods) are directly transferred to consumers at the point of sale. Since the CPI is the primary indicator used to measure inflation in an economy, the PPI is a preview of changes in the rate of inflation.

PPI in manufacturing measures the rate of change in prices of products sold as they leave the producer. They exclude any taxes, transportation and trade margins that the purchaser may have to pay. PPIs provide measures of the average movements of prices received by the producers of various commodities. They are often seen as advanced indicators of price changes throughout the economy, including changes in the prices of consumer goods and services. Manufacturing covers the production of semi-processed goods and other intermediate goods as well as final products such as consumer goods and capital equipment. A variety of price indices may be used to measure inflation in an economy. These include Consumer Price Indices (CPI), price indices relating to specific goods and/or services, GDP Deflators and Producer Price Indices (PPI). This indicator is presented for total market and domestic market and is measured in terms of the annual growth rate and in the index.

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