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6427.0.55.003 - Information Paper: Review of the Producer and International Trade Price Indexes, 2011  
Latest ISSUE Released at 11:30 AM (CANBERRA TIME) 02/09/2011  First Issue
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APPENDIX 2 – THE STAGE OF PRODUCTION CONCEPT


The following is a modified extract from Information Paper: Producer Price Index Developments (cat. no. 6422.0).


THE STAGE OF PRODUCTION (SOP) CONCEPT

Under the SOP concept, flows of products (goods and services) are categorised according to their economic destination on a sequential basis along the production chain. The basis for the categorisation is the Australian Input-Output tables. The primary categorisation is between final products (i.e. products destined for final consumption, capital formation or export) and non-final products (i.e. products that flow into intermediate consumption for further processing).

This initial breakdown of the product flows into final and non-final products represents a useful economic dissection of producers’ transactions. However, the non–final products can flow into the production of both final and other non-final products.

Therefore, to aid analysis, the non-final product flows can be divided on a sequential basis between Stage 1 (or preliminary) products and Stage 2 (or intermediate) products, as illustrated below. This approach would generate three separate stages of production. In order to avoid multiple counting of transactions, the three stages are not aggregated.

Under such a framework, preliminary (Stage 1) products are used in the production of intermediate (Stage 2) products; in turn, intermediate (Stage 2) products flow into the production of final (Stage 3) products. For each of the three stages, products can be categorised into domestic production and imports. The final (Stage 3) products can be further divided between capital, consumption and exports.

The framework allows for analyses of price change as products flow through production processes. Price indexes for earlier stages of production may be indicators of possible future price changes for later stages.

The scope of the SOP framework is broadly analogous with that of gross output under the production approach to the measurement of Gross Domestic Product (GDP(P)) in the national accounts system.


SCOPE AND COVERAGE

Producer price indexes conventionally relate to the output of domestic industries, at basic prices, either inclusive or exclusive of exports. In order to provide for more complete analyses, exports, as well as domestic usage, of Australia’s output have been included within the scope of the SOP index model.

Imports have also been incorporated within the framework, recognising that they represent a very important potential source of inflationary pressures. The model therefore allows for the monitoring of the effects of price changes of both domestically produced and imported products.

Conceptually, the scope of the indexes is economy-wide relating to the output of all the goods and services industries. However, for reasons of data availability, the coverage is restricted to a greater coverage of goods than services.

The SOP index model consists of the major aggregates shown in Diagram 3.


Diagram 3 – Stage of Production index model

Picture: Diagram 3 shows the Stage of Production index model


For some analyses, the focus would be on the domestic economy, with exports treated as a leakage. For such purposes, the relevant Final (Stage 3) goods index would be exclusive of the Exports component of Domestic goods (that is, the Domestic Consumption plus Capital goods aggregate).


TRANSACTION FLOW APPROACH

The ABS has adopted a transaction flow approach in disaggregating output into the various production stages. This approach means that the assignment of a product to a stage is based on the proximity of its use in final demand.

Alternative degree of fabrication or principal destination approaches are employed by statistical agencies in some other countries (which, incidentally, tend to use the term Stage of Processing rather than Stage of Production as used in Australia).

The degree of fabrication and principal destination approaches result in the allocation of particular products to one, and only one, stage. This would present particular problems for Australia because of our very open economy in which exports (and imports) measure a large proportion of GDP. Products such as wheat, wool and iron ore are exported in large volumes as well as being further processed locally. The allocation of such products to a single stage would, by necessity, be very arbitrary.

While exports of agricultural and mining products constitute final demand from the perspective of the domestic economy, they are in fact intermediate inputs into other countries’ production. Adopting the transactions flow approach means, for example, that exported wheat and domestically used wheat are effectively treated as different products for index construction purposes. Certainly their prices relate to different classes of transactions with different price experiences in different markets.

Under this more flexible transaction flow approach, it is the transactions in a given product that are allocated to the relevant market within the production chain. Product transactions can therefore be allocated to more than one stage, as illustrated by the examples below.


Diagram 4: Expanded example of Stage of Production framework – allocation of products by stage
Picture: Diagram 4 shows an expanded example of the Stage of Production framework - allocation of products by stage


In the first example above, Bauxite as a Preliminary (Stage 1) product is an input into the production of Alumina. In turn Alumina is an Intermediate (Stage 2) product which is then used to produce Aluminium, a Final product (destined for final consumption, capital formation or the export market).

The next example shows Bauxite, as an Intermediate (Stage 2) product, used to produce Alumina which is subsequently exported as a Final (Stage 3) product.

Under the third example, Bauxite that is sold direct to the export market without further processing in Australia is a Final (Stage 3) product.

The other examples above show similar categorisation of different sugar and meat products.

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