Producer Price Index - Assignment Example

Producer Price Index Table of Contents Answer to Question Number 3 Answer to Question Number 2 3 Answer to Question Number 3 5 Answer to Question Number 4 5 Answer to Question Number 5 6 References 8 D’Souza, E. (2009). Macroeconomics. USA: Pearson Education. 8 Gwartney, J. D., Stroup, R. L., Sobel, R. S. & MacPherson, D. (2006). Economics: private & public choice (11th Edition). USA: Thomson. 8 Mankiw, N. G. (2008). Principles of Economics (5th Edition). Ohio, USA: South-Western Cengage Learning. 8 Yamarone, R. (2007). The Traders Guide to Key Economic Indicators. New York, USA: Bloomberg Press. 8 Bibliography 8 Mankiw, N. G. & Taylor, M. P. (2006). Economics. USA: Thomson. 8 Answer to Question Number 1 Producer price index is one of the price indices used for measuring inflation in an economy. Also known as wholesale price index, it is mainly meant for the convenience of the manufacturers in a nation. PPI helps the manufacturers to keep a track of the changes in the sale prices or rather value additions along the production in process, i.e., before the retail price is determined. Hence, the index could well be considered as the one estimating the price of the basket of all intermediate products and raw materials being used in production. In other words, PPI includes the prices of all those items omitted from the calculation of Consumer Price Index. The index is measured on a monthly basis, including the prices of manufacturing items according to their contribution in the nation’s GDP. Apart from updating the producers, the importance of PPI lies in helping the observers to predict about the upcoming CPI index and hence measure the expected inflation value. In addition, it also assists them to seek out the exact channels which have contributed to any inflation at the retail level. Since PPI figures out the changes in prices of raw materials and intermediate goods, it helps the economists to analyse the exact avenues that might have led to any abnormality in price, i.e., whether it is caused by a shift in the demand-supply schedule or any other exogenous factor (Yamarone, 2007). Answer to Question Number 2 The purpose of both Producer Price Index and Consumer Price Index is to measure the rate of inflation in any given economy. However, the perspectives or the dimensions that each of them cover are different from each other in the sense that each of them consider a different sub-set of all the goods that an economy produces. Producer price index, also known as Wholesale Price Index, calculates the average price level of the raw materials and intermediate goods being used during the production process. On the other hand, the CPI is all about the retail prices of the final goods sold in the market. Hence, while the former is meant for the manufacturers in the nation, the consumers are more concerned about the PPI. A detailed distinction between the two measures has been presented in the following paragraph. Consumer Price Index The consumer price index is measured for a given basket of consumer goods in an economy. It is calculated by the government of any nation through considering the average expenses being incurred by an average household in the economy. A survey is made on the basis of which a list of all the goods being consumed by an average consumer is created and then the proportion of money being spent on a particular item is sought out. A mean estimation is made at an aggregate level where the gross proportion of money expended out on a particular commodity is considered with respect to the GDP of the nation. For instance, in USA, the weight associated to light and fuel in the CPI index is 6.43 out of 100 and that on clothing, bedding and footwear is 6.58 out of 100. The government of any nation prepares many other sub-categories of CPI for the convenience of various customer groups, viz., industrial workers, agricultural workers, urban residents, etc. Producer Price Index Producer Price Index, also known as Wholesale Price Index is calculated at the value addition level, i.e., at a time when the production process is still on its way. It is the price level being calculated after taking into account all the intermediate products and raw materials being used in a production process. Though the basket of commodities being considered in this case is vastly different from the one meant for the consumers in a nation, the methodology to calculate the former remains the same, i.e., through considering a weighted proportion in the GDP of the nation. Another important aspect that distinguishes the two measures of inflation, or rather makes the PPI a superior one is that, it is possible to predict the future CPI from PPI values in the previous period (D’Souza, 2009). Answer to Question Number 3 Producer Price Indices are the reflectors of the level of inflation that the nation is about to experience in future. It helps to forecast the rate of CPI in the future and thus the burden of any price changes (inflation or deflation) that the nationals have to shoulder. Hence, any abnormality in the former is bound to affect the consumption level in the nation and thus affect its GDP. So, there is need for the government to intervene to keep the national consumption level stable. Moreover, in the absence of any monitoring instruments, the producers might show unjustified rises in the prices of the raw materials being used in production, so that they can justify increases in the retail prices of a large number of commodities making a use of such intermediate goods, at a later stage. However, this might prove detrimental for the consumption level and ultimately lead to inflation, with all the profits being extracted out from a falsely boosted up final price, being pocketed by the producer. Hence, it is necessary for the government to analyse in details about the exact positions of demand and supply schedules at each and every stage in the production process. A price bubble, i.e., one which is not supported by fundamentals and is escalated wrongly for the benefits of a single class in the society, can have spiteful impact on the economy in the longer term too. A good example of the same could be cited from the recent case of the house price bubble in the US economy that submerged the nation in a sub-prime crisis and created a worldwide financial ruckus. Had the government of the nation monitored the growing abnormality in the sector, the broader economic discrepancies could have been avoided. Answer to Question Number 4 Consumer Price Index and GDP deflators are two separate measures of general price indices in a nation. However, CPI is a more specific index measure than GDP deflator, since the former attends to the changes in price levels of a particular set of commodities and services being produced in a nation, which is also known as the basket of consumer goods. On the contrary, GDP deflator is responsible for calculating the average price level of all commodities and services being produced in an economy, or rather, those included in evaluating the economy’s GDP. Hence, it might be said that CPI calculates the general price level of consumer goods only, which is only a subset of the aggregate number of goods being produced in a nation; whereas, GDP deflator includes the consumer goods as well as other industrial or capital goods (Gwartney, Stroup, Sobel & MacPherson, 2006). Answer to Question Number 5 Evident from the answer to the previous question, there is a slight difference between the two measures of inflation. While CPI measures the rate of inflation in context of a basket of consumer goods, the GDP deflator is responsible for estimating the general price level of all commodities produced in the nation and included in its GDP. Hence, changes in the price of a particular consumer good will have a greater impact on the Consumer Price Index and show a considerable amount of inflation, than is exhibited in the GDP deflator for the same period of time. For instance, if the prices of cars rise considerably from the beginning of 2008 to that of 2009, it will have a greater impact on the Consumer Price Index, which allots a greater weight to the commodity than is associated with it in calculating the GDP deflator. Thus, the change will make little difference to the latter measure than what it had been in the previous year. A lower impact might not create a huge concern among the population about any inflationary changes, so that the effect of the same event subsides merely through a change in the measure of inflation. Another slight area of distinction between the two measures is related to the basket of goods being included in measuring each of them. In case of CPI, the basket of goods whose price level is being considered remains almost fixed over time; rather it stays more stable than that for measuring the GDP deflator. This is because, the items being consumed by the population rarely changes over time. On the other hand, all those goods being currently produced in the nation are included in the basket of goods for measuring GDP deflator. Since the items being produced in a nation depends on a number of external economic and political factors, they keep on changing over time. Hence, it could be said that the basket of consumer goods (used to measure CPI) remains more stable than the basket of total goods (used to measure GDP deflator) being produced in a nation at any point of time (Mankiw, 2008). References D’Souza, E. (2009). Macroeconomics. USA: Pearson Education. Gwartney, J. D., Stroup, R. L., Sobel, R. S. & MacPherson, D. (2006). Economics: private & public choice (11th Edition). USA: Thomson. Mankiw, N. G. (2008). Principles of Economics (5th Edition). Ohio, USA: South-Western Cengage Learning. Yamarone, R. (2007). The Traders Guide to Key Economic Indicators. New York, USA: Bloomberg Press. Bibliography Mankiw, N. G. & Taylor, M. P. (2006). Economics. USA: Thomson. Read More