Price Indexes

Overview
What is a price index?
Basics of price indexes
Inflation flows in the economy
The suite of price indexes
About the CPI, PPI, CGPI, LCI & OTI
Price index mechanics
Interpreting price index outputs
What is inflation?
Inflation is a general term referring to an increase in the
general or average level of prices of goods and services
over time

Price indexes are used to measure inflation
What is a price index?
Decomposing changes in value
Movements in a time series of monetary values can be
decomposed into two elements:

Changes in price

Changes in volume

Ratio of change in value = ratio of change in price x ratio of
change in volume

Example
Variable Period 0 Period 1 Period 2 Period 3
Price per kg ($) 1.50 2.00 2.00 2.60
Quantity (kg) 100 100 80 100
Value ($) 150 200 160 260
Percentage change from previous period
Price per kg ($) .. 33.3 0.0 30.0
Quantity (kg) .. 0.0 -20.0 25.0
Value ($) .. 33.3 -20.0 62.5
What is a price index?
A statistic used to measure the overall level of change in
prices being paid by purchasers or being received by
sellers

A series of numbers that shows how a whole set of
prices has changed over time

What is a price index?
The average price level of goods and services in a
single period, called the index reference period, is
assigned an index number of 1000

The index number for each subsequent period is
calculated such that its ratio to the base period index
number is the same as the ratio of the average price
level in that period to the average price level in the
base period

Example: Current index=1150 means prices are 15%
higher, on average, than in the index reference period


Basics of price indexes
A common approach is to compare the expenditure or
revenue of a basket of goods and services purchased
or sold in one of the two periods with what the same
basket would have cost or returned in the other of the
two periods

This is called a fixed-basket approach to price index
construction
How is a price index calculated?
For practical reasons, the basket of goods and services
usually relates to some earlier (usually annual) period of
time

The most commonly used index of this type is called a
Laspeyres price index
Some price index terminology
Price reference period
The month or quarter in which the base period prices are
selected, i.e. p
0
Weight reference period
The year or years from which weighting data was derived,
i.e. w
0
Index reference period
The period or periods for which the index number is set to
1000 for comparison with index numbers for other periods
Laspeyres price index formula
I
t
=


=
=
n
i
i i
n
i
i it
q p
q p
1
0 0
1
0
x 1000
Where:
I
t
= price index for period t
p
it
= price of ith product in period t
p
i0
= price of ith product in base period
q
i0
= quantity of ith product in base period
Laspeyres formula
It is usually more feasible to collect expenditure or
revenue information than it is to collect quantity
information

The Laspeyres formula can be re-arranged and
expressed in an equivalent price-relative form
Laspeyres formula (price-relative)
I
t
=


=
=
|
|
.
|


\
|
n
i
i
n
i
i
it
i
w
p
p
w
1
0
1
0
0
x 1000
Where:
I
t
= price index for period t
p
it
= price of ith product in period t
p
i0
= price of ith product in base period
w
i0
= expenditure or revenue base weight of ith product
Why are price indexes produced?
To measure inflation in various parts of the economy

Common uses include:
monitoring monetary policy
adjust wages or benefit payments
decompose value change into price & volume change
deflate a value series to get volume series
contract indexation


Differences between the indexes
Each index measures a different set of transactions
Product origin (domestic or imported)
Destination (business, government, consumers or overseas)
End use (capital, consumption or labour)

Suite of price indexes covers various parts of the
economy
Inflation flows in the economy
Expenditure by household sector
Production sector
outputs
Expenditure by production/government sector
Import Price Index
Export Price Index
Labour
costs
Capital
costs
Current
costs
Consumers
Price Index
Capital Goods
Price Index
Producers Price
Index (inputs)
Labour Cost Index
Inflation Flows in the Economy
Producers
Price Index
(outputs)
The suite of price indexes
Consumers Price Index (CPI) & Food Price Index (FPI)
Producers Price Index (PPI)
Capital Goods Price Index (CGPI)
Farm Expenses Price Index (FEPI)
Overseas Trade Price Indexes (OTI)
Labour Cost Index (LCI)
Consumers Price Index
Measure of the changing cost of goods and services
purchased by private NZ households

Uses
Monitor monetary policy Policy Targets Agreement
Adjust NZ superannuation & benefit payments
Wage negotiations

Consumers Price Index
About 690 representative
goods and services
11 main groups
-Food
-Alcoholic beverages and tobacco
-Clothing and footwear
-Housing and household utilities
-Household contents and services
-Health







-Transport
-Communication
-Recreation and culture
-Education
-Miscellaneous goods and services
Consumers Price Index
Expenditure weight
Represent relative importance
Higher expenditure = higher weight
Household Economic Survey (HES)
Under-reported items
Other sources
Transaction data
Information provided by businesses
Government admin data
Other Statistics NZ surveys

Consumers Price Index
Collection
Visiting retail outlets
Postal surveys
Internet & email
Constant quality
Releases
CPI quarterly, FPI monthly
Tradables/ non-tradables, exclusion based series, core
inflation measures
Producers Price Index & FEPI
Measures price changes in production sector
Inputs tracks cost of production
Outputs tracks prices received by producers
Farm Expenses Price Index (FEPI) tracks prices of fixed
inputs to farming industry
Uses
National Accounts real GDP
Contract indexation
Analysis of inflationary trends
Economic forecasting

Producers Price Index
PPI Output indexes
Primary products
Manufactured goods
Services
etc
PPI Input indexes
Materials
Fuels and electricity
Transport and communication
etc

Producers Price Index
Expenditure weights
Commodity Data Collection
Annual Enterprise Survey
Collection
Commodity Price Survey
10,000 commodity items & 2,500 respondents
Single price quote used in multiple industries
Laspeyres index formula
Quarterly release

Capital Goods Price Index
Measures price changes in physical capital assets
Uses
Deflator to calculate real expenditure on
Gross Fixed Capital Formation
Contract indexation
Exclusions
Large value non-recurring items, e.g. aircraft
Second-hand equipment
Six asset groups:
Residential buildings, Non-residential buildings, Other construction,
Land improvements, Transport equipment and Plant, machinery &
equipment
Capital Goods Price Index
Expenditure weights
Statistics on external trade, manufacturing & building, vehicle
registrations
Information from manufacturers, importers, wholesalers, retailers
Data over several years rather than a single year
Collection
Commodity Price Survey
Data from other publications
Releases
Quarterly
Same day as PPI

Overseas Trade Indexes
Overseas merchandise trade price index
Measures price movements of merchandises imported and
exported
Overseas service trade price index
Measures price movements of services imported and exported
Exchange rate effect
NZD decline = upward influence on export and import prices
NZD rise = downward influence on export & import prices
Overseas Trade Indexes
Structure
Import commodity groups, e.g. petroleum & petroleum
products
export commodity groups, e.g. dairy products
Import and export services categories
Transportation
Travel
Other services
Government services
Expenditure weights
NZ Customs Service data
Weights vary from period to period

Overseas Trade Indexes
Collection
Unit values derived from Customs value and quantity data
Commodity Price Survey
International price indexes for some items
Calculation
Fisher Ideal index formula
Reflects current period weights AND base period weights
from earlier period
Services trade index = Laspeyres formula
Quarterly release
Together with volume and value series
Labour Cost Index
Wage & salary rates and Non-wage labour costs
Uses
Wage negotiations
Contract indexation (in conjunction with PPI Input indexes)
Monitor wage movements
Structure
Sector of ownership, industry and occupation groupings
Expenditure weights
Census, QES, LEED, Business Frame, Labour Cost Survey

Labour Cost Index
Collection
Labour Cost Survey
Quality
Index measures fixed quantity and quality of labour
Respondents provide reasons for movements
Job descriptions recorded in detail
Releases
Wage & salary rates = Quarterly
Non-wage and All labour costs = June quarter only
Labour Cost Index
LCI & QES
Share media release
LCI measures pay rates for fixed set of job descriptions,
keeping quality constant
QES measures average hourly earnings, affected by
compositional changes in workforce
Unadjusted LCI
Analytical series
Includes performance-related changes in pay rates

How to read a price index
Price index is about price change NOT price levels
Example: The index numbers for petrol and bread for a given
quarter are 1300 and 1150, respectively
Does this mean the price of petrol is higher than that of bread?
NO! All we can tell is that the price of petrol has risen more (up
30%) than bread (up 15%) since the index reference period
Index numbers provide no information about the actual price
Example:




Index
number
Percentage
change (month
to month)
Percentage
change(base to
current month)
Month 1 1000
Month 2 1500 50 50
Month 3 1650 10 65
How to read a price index
Price index: tells how the value of something at a
point in time compares to the value of the same thing
at another point in time
An index number on its own means nothing
Must be compared with an index number from
another period to determine the price movement
Index reference period = 1000
Example: if the index number of a given period is
1250, then prices have increased by 25% since the
index reference period.
How to read a price index
Percentage change
Price index movements commonly expressed as % change
Percentage change calculation
From previous to current period:
Shortcut:

Cumulative percentages
Price movement for the whole year also useful
Index movements cannot be calculated by adding the
percentage results between intervening periods
100
1
1

t
t t
I
I I
100 1
1

|
|
.
|

\
|

t
t
I
I
Spatial vs temporal indexes
Temporal = measures differences in price
levels over time
CPI, PPI, FEPI, CGPI, OTI, LCI
Cannot be used to compare price levels across
cities or countries

Spatial = measures differences in price levels
across space
Cost of living index
Purchasing Power Parity programme
Big Mac Index


National Accounts
National Accounts: provide a
comprehensive accounting framework within
which economic data can be compiled and
presented in a format that is designed for
the purpose of economic analysis, decision-
taking and policy-making.

Source: OECD
August 7th 2007
Uses of National Accounts
Uses include:
Measuring economic performance and impact
of economic and financial policies
Economic analysis and forecasting
International comparisons
Yardstick for economic and social comparison
The Economic Model
Households
Producers
Government
Financial intermediaries
Rest of the world
GOVERNMENT HOUSEHOLDS PRODUCERS
CONSUMPTION SPENDING
GOODS AND SERVICES
INCOME
PRODUCTIVE SERVICES
taxes
taxes
services
services
FINANCIAL SECTOR
OVERSEAS SECTOR
SAVINGS/LENDING INVESTMENT
IMPORTS EXPORTS
National Accounts Measures
Gross Domestic Product (GDP)
Household Income and Outlay account
Capital accounts
Tourism Satellite accounts
Institutional Sector accounts
Non-profit institutions accounts
Productivity measures

Measuring Economic Activity
gross domestic product: production
measure - what each separate producer
adds to the value of final output (value
added), after deducting intermediate
consumption from gross output. Value
added is summed for all producers.
Measuring Economic Activity
gross domestic product: income measure -
the incomes received by the owners of the
factors of production. These represent the
returns to the labour and capital employed
such as wages and salaries, and profits.
Measuring Economic Activity
Expenditure on GDP (expenditure measure) - relates
to final purchases of goods and services produced in
the New Zealand domestic territory.
The sum of all final demands, that is, final
consumption expenditures (of households,
government and private non-profit institutions serving
households), changes in inventories, gross capital
formation, and net exports.
Gross Domestic Product
Current price
series
Chain-volume
series
Annual Production
Income
Expenditure
Production
Expenditure

Quarterly Expenditure

Production
Expenditure

Quarterly GDP is in constant prices
Also known as real GDP, ie price
effects are removed
This means that any movement we
report is the result of increased or
decreased production, and not just a
change in prices
Annual National Accounts
Current price production and expenditure
are reconciled in a Supply-Use framework
Supply = Use


Quarterly figures move beyond the latest
annual National Accounts using these as
Benchmarks
0
10
20
30
40
50
60
70
Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8
quarterly data
annual data
benchmarked quarterly data
QGDP is seasonally adjusted
We remove the impacts of seasonal changes
from the series
Movements are the result of the underlying
trend or of irregular events.
For example:
- a severe drought that lowers the amount of milk produced would impact
negatively on GDP (irregular event)
- the natural increase in population that leads to more students being taught in
schools will impact positively on GDP (trend)
- the increase in retail sales prior to Christmas will not generally be noticeable
in GDP (seasonal event)
Summing industry movements does not give
the overall GDP result

Our series are chain-linked, which means we update
the pricing weights of industries each year
This ensures our weights are reflective of changes in
market structure
e.g. prices of computers have dropped steeply over the last decades and
purchases have increased. If we did not update our pricing weights we would
end up overstating the volume sold and understating the price change
A consequence is that you cannot add the
movements for each industry in GDP together to get
the total economy movement