Price Index

Price index shows the weighted average of the combined prices of a selected group of goods and services in accordance with their prices in a certain base year. It is a statistic intended to compare different price relatives when taken as a whole, and find out how they differ between time periods and in different geographical locations.

Price indexes are normalized averages of price relatives for specific categories of goods and services in a given location, within a given period of time. An increase in the general price level (i.e. inflation), can also be measured accurately using a price index.

How Price Index is Determined

In order to construct a price index, a base year is first selected. A representative sample of goods and services is then taken for the base year, to calculate the value using current prices. The index price will be the resulting ratio of expenditures on the group of goods and services at current prices to the expenditure on the same group of goods and services at the base year price.

There are several potential uses for price indexes. In terms of indexes which are especially broad, the index can be targeted to measure the general price level or the cost of living in an economy. Narrower price indexes can be effective for managers and producers with business plans and pricing. They are also sometimes useful as a guide for people who invest.

Some important price indexes include:

House Price Indexes in the United Kingdom

Since about 1973, House Price Indexes (HPIs) have been generated in the UK by both mortgage providers and government bodies alike. Property market websites have also recently joined in to produce house price indexes. There is an increasing strength of upward development in the price of houses across the UK and the highest growth is recorded in London. In 2014, UK house prices increased by 10.5% in May from 9.9% in April.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) is a price index that considers the weighted average of the prices of a group of consumer products and services like food, medical care and transportation. To calculate consumer price index, price changes for each item in the predetermined group of goods are taken and averaged. Changes in CPI are used to measure price changes connected with living costs in a particular area. Statistics from consumer price index are frequently used for earmarking periods of inflation or deflation as they occur.

Producer Price Index

Producer Price Index (PPI), formerly known as Wholesale Price Index refers to a weighted index of prices assessed at the producer or wholesale level. It shows trends within wholesale markets, commodity markets and manufacturing industries.

On the national level, producer price index shows three index figures; each one covering crude, intermediate and finished goods.

  • PPI Commodity Index (crude): the average price change from the previous month for certain commodities such as coal, crude oil and energy.
  • PPI Stage of Processing (Intermediate): the products here have been manufactured to some extent but will be sold to further producers who will create the complete product. Examples include cotton, lumber, steel and diesel fuel.
  • PPI Industry Index (finished product): this involves the final stage of manufacturing, and is the main source of Producer Price Index.

The finished product, i.e. core PPI figure is the focus, it includes the finished goods index minus the components of energy and food, which are subtracted as a result of their high instability. The focus therefore is on the percentage of change in producer price index from the prior period, and on the yearly projected rate.

What Producer Price Index Means for Investors

For investors, the most important quality of the producer price index is its ability to predict the consumer price index (CPI). A lot of the increase in cost experienced b retailers get passed on to consumers. Therefore, because of the presence of an inflation indicator, i.e. the CPI, investors seek to acquire a preview through examining the producer price index figures. The federal government is also aware of this, and therefore intently examines producer price index reports to get a level of certainty on future policies that might be made to combat inflation.

There are certain downsides to this approach however. Relative weightings used for different industries by the PPI might not be an accurate representation of their proportion to their real GDP (Gross Domestic Product). Despite the weightings being adjusted every few years, there are still some differences that occur.

In addition, calculations of producer price index involve definite “quality adjustment method” which are sometimes referred to as hedonic adjustments, all of which account for changes occurring in the quantity and measure of product usefulness over a period. However, the adjustments might not be effective at separating quality adjustments from changing price levels as intended.

Import and Export Price Index

An import price index evaluates changes in the cost of import of merchandise (goods and services) into a country. The index numbers calculated for each reference period refers to the prices of goods imported into the country within the specified period.

An export price index refers to an index that is calculated for the prices of a single or specified group of goods entering into international trade using export prices.

In the United States, import price index and export price index are two indexes that supervise the prices of imports and exports. The indexes are created by compiling the prices of imports, i.e. products purchased in the U.S. but produced outside the country, and the prices of products purchased outside the country but manufactured in the country, i.e. exports.

The import and export price indexes produce data that more often than not create a direct impact on the bond markets. Both indexes are employed to take measurements of inflation in globally traded products. When importing inflation becomes too high, bond prices will usually decrease. This is because it shrinks the original investment value i.e. the principal investment is reduced.

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Published on 9th June 2017

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