producer price indices - recommendations of international manuals

United Nations Economic Commission for EuropeStatistical DivisionUnited Nations Economic Commission for EuropeStatistical Division

Producer Price Indices -Recommendations of international manuals

Joint EFTA/UNECE/SSCU Seminar

July 2007

Presentation by Carsten B. Hansen, UNECE

July 2007 UNECE Statistical Division Slide 2

Overview

1. The family of PPIs

2. The international manuals

3. Calculation of the PPI

4. Basic measures

5. Quality adjustments


The family of PPIs

Producer price indices

Output PPIs Input PPIs

PPI – Production for the domestic market

PPI – Production for export

PPI – Total production

PPI – Input from the domestic market

PPI – Total input

PPI – Input from imports


The international manuals

Producer Price Index Manual. Theory and Practice (2004). Electronic version available on www.imf.org/external/np/sta/tegppi/index.htm

Export and Import Price index Manual – planned to be published late 2007/early 2008. Draft chapters available on www.imf.org/external/np/sta/tegeipi/index.htm


1. Introduction2. Background and uses of PPIs3. Coverage and classifications4. Weights and their sources5. Sampling6. Price collection7. Treatment of quality change8. Item substitution and new

products9. PPI calculation in practice10. Treatment of specific products11. Errors and bias in the PPI12. Organization & management

13. Publication and dissemination14. The system of price statistics15. Basic index number theory16. Axiomatic and stochastic

approaches17. The economic approach18. Aggregation issues19. Price index using an artificial

data set20. Elementary indices21. Quality change and hedonics22. Seasonal products

Overview of the PPI Manual


Calculation of elementary indices

Elementary price indices can be calculated as

Unweighted averages:

• The arithmetic mean of the price ratios – Carli index

• The ratio of arithmetic mean prices – Dutot index

• The geometric mean of the price ratios = the ratio of geometric mean prices – Jevons index



Weighted averages:

• Laspeyres price index

• Geometric Laspeyres price index

Caution: Explicit weights in Dutot indices may conflict with the implicit weighting by the price level in this type of an index

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How to decide which formula to apply?

• The axiomatic or test approach - focuses on the statistical properties of the index

• The economic approach - focuses on the economic interpretation of the index



The economic approach to output PPIs

Assuming revenue maximizing producers it shows the ratio of Revenues, R, with fixed input and technology, v: R(pt,v)/R(p0,v)

• Producers keep fixed relative quantities => Carli or Dutot appropriate

• Producers keep fixed revenue shares (not very likely!) => Jevons to be preferred

• Laspeyres and Paasche provides the lower and upper bounds to the economic/theoretical output PPI, under normal conditions



The economic approach to input PPIs

Assuming cost minimizing producers, it shows the ratio of costs (C) with fixed output and technology, y: C(pt,y)/C(p0,y)

• Producers (purchasers) keep fixed relative input quantities => Carli or Dutot appropriate – not always the case in practice

• Producers (purchasers) keep fixed input value shares => Jevons to be preferred

• Paasche and Laspeyres provides the lower and upper bounds to the economic/theoretical input PPI, under normal conditions

However, the assumptions are often not fulfilled in reality =>The economic approach does not provide clear answers about what formula to use



Conclusions:

• Jevons has better statistical properties• Don’t give too much weight on the economic approach

for elementary indices• Jevons or Carli may be used for most elementary indices• Dutot should only be used for elementary aggregates that

consists of strictly homogenous products

• A chained Carli should not be used because of build-in upward bias

• If weights are available, Laspeyres or Geometric Laspeyres indices may be calculated.

• Be careful to apply weights in Dutot indices


Basic measures

The prices:• Output PPI: The prices received by the producer, i.e. basic

prices (SNA) excluding taxes plus subsidies• Input PPIs: The price actually paid by the purchaser, including

taxes net of subsidies, i.e. purchasers‘ prices

Transfer prices• Becomes more common as (international) trade is growing and

posses serious measurement problems• Often they do not reflect real market prices. In such cases:

• Use estimated or imputed prices, or• Exclude the transfer prices from the index


Basic measures

The coverage of production and establishments:• The statistical unit for the PPI is usually the output generating

entity, the establishment, as outlined in the SNA• However, globalization, outsourcing and the emergence of

virtual corporations etc. makes the identification of the statistical unit still more difficult in practice

Be as close as possible to the principle target of the PPI Coordinate with National Accounts (NA):

- NA may provide the weighting data- A main use of PPIs is deflation of NA data

Thus, a consistent approach should be aimed at


Quality adjustments

• The pace of innovation is high, leading to continual changes in the quality of products

• There is not much consistency among countries in the methods they use to deal with quality change

• Empirical studies indicate that the choice of method can lead to very different results

• The way in which a product is replaced by another always imply some assumption about the relative qualities of the 2 products

• – You cannot “do nothing”!


Methods for Quality adjustments

a) Direct comparison: The price of the new product is compared directly with the price of the old one. Assumption: the 2 are of similar quality and the whole price change is included in the index

b) “Link to show no change”: The price of the new item is linked into the index. The price change is assumed to equal the quality change and thus not included in the index calculation

c) Overlapping prices: With overlapping prices the new item can be linked into the index. This assumes that the price difference reflects the value of any quality difference between the two items



d) Matched models only. Only those products for which a price is recorded in both the current and the reference period are included in the calculation of the elementary index. This corresponds to imputation, where the price development of the new product is estimated by the average price development of those product for which matched prices have been recorded

e) Option prices: If the difference between A and C is the inclusion of an extra option, e.g. a CD-ROM drive in a computer, the extra option can be separately priced and appropriate adjustment made in the recorded price



f) Production costs: Producers can be asked about the difference in cost of producing the old and new item, and the ratio of costs be applied for adjusting the prices

g) Experts judgement: Persons with detailed product knowledge value the difference between the new and old product, and appropriate adjustment are made in the recorded prices

h) Hedonic adjustments by use of hedonic regression. Resource and data demanding


A, B and C Methods for QA

The Handbook on price and volume measures in national accounts (Eurostat 2001) divides the quality adjustment methods into three groups:

A methods: most appropriate methods

B methods: those methods, which can be used in case an A method cannot be applied

C methods: those methods, which shall not be used

The Handbook provides useful guidance and numerous practical examples. It is available from Eurostat’s webpage

The Voorburg Group on Services Statistics also provides useful information. Webpage: http://www4.statcan.ca/english/voorburg/


Unique products

Unique products pose a special problem for quality adjustments in PPIs. For example:

• major equipment projects, special machineries, ships and aircrafts

• IT, management and other types of business services• Telecommunication; tailored equipment and service

agreements• Transport services

=> It is not possible to “compare like with like” and the value of possible quality changes is difficult to estimate


Unique products – Model pricing

Model Pricing:

• Construct a model by combining a set of components that can be priced over time. The model should be as representative as possible. It does not have to be a project actually produced or sold on the market.

• The following criteria applies:

• The model needs regular update to ensure that it continues to be representative

• The model should be defined in terms of outputs, not inputs

• The prices used should be the actual charged prices, taking account of profit margins and discounts offered to costumers


Unique products – Specification prices

Specification Prices:

• Break down a real product into its key elements. In the successive periods individual projects are examined and the prices of the matched set of elements are compared. No ideal, representative model has to be constructed or updated

• The following criteria applies:

• The key elements may become less relevant over time and will need to be updated regularly

• The key elements should be specified in terms of outputs rather than inputs


International prices

The use of international price indices is an acceptable (B) method if they can be considered representative of the price development in the country. Examples:

- Energy and raw material prices- Computers

• For example, US compiled hedonic based indices for computers and peripherals available on Internet may be used as a data source, adjusting for exchange rate changes if needed

producer price indices - recommendations of international manuals

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