6429.0 - Producer and International Trade Price Indexes: Concepts, Sources and Methods, 2014  
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CHAPTER 2 CONCEPTS, PURPOSE AND USE


CONCEPTS

2.1 The principal purpose of the Australian Producer Price Indexes (PPIs) and International Trade Price Indexes (ITPIs) is to measure inflation by industry to support the compilation of the Australian National Accounts and the Balance of Payments.

2.2 The Australian PPIs measure the change in the prices of products (goods and services) as they leave the place of production or as they enter the production process. PPIs and ITPIs fall into two categories: indexes which refer to input prices (that is, at purchasers' prices), and those which refer to output prices (that is, at either basic or producers’ prices). The ITPI measures changes in the prices of goods imported into Australia (the Import Price Index (IPI)) and goods exported from Australia (the Export Price Index (EPI)).

2.3 The PPIs and ITPIs provide a comparison of changes in the price of a fixed collection (basket) of products between one period and a reference period fixed at some point in time.

2.4 PPIs and ITPIs do not measure price levels, nor do they measure the value or cost of production.


Input price indexes

2.5 The valuation basis for the transactions covered by an input price index is purchasers’ prices. Purchasers’ prices are inclusive of non-deductible taxes on products, and transport and trade margins (that is, the prices recorded in the index should be the actual price paid by the user which relates to the price of products delivered into store, delivered on site, etc.).

2.6 Input price indexes measure the average change in the prices of products used in the production process. These products or intermediate inputs to the production process are products produced elsewhere in the domestic economy, or are imported. Primary inputs such as land, labour and capital are excluded from PPIs.


Output price indexes

2.7 The preferred valuation basis for the transactions covered by an output price index is at basic prices, although producer prices may be used when valuation at basic prices is not feasible. Both basic and producer prices are prices that exclude transport and trade margins. The distinction between basic and producer prices relates to the treatment of taxes and subsidies on products. Basic prices are prices before taxes on products are added and subsidies on products are subtracted. Producers’ prices include, in addition to basic prices, taxes less subsidies on products (excluding value added taxes. The point at which prices are measured is ex-factory, ex-farm, ex-service provider, etc.).

2.8 The main difference between basic and producer prices is generally any per unit subsidy that the producer receives. However, on occasions producer prices may have to be used when information on subsidies is not available. In most instances, producers in the Australian economy do not receive subsidies, in which case the producer prices and basic prices will be the same.

2.9 ABS output price indexes measure the prices received by producers irrespective of whether their products are sold on the domestic market or as exports.


Practical issues in price measurement

2.10 On occasion conceptually pure prices cannot be obtained and transaction prices that include transport margins, for example, are used to compile price indexes. In these circumstances pricing on a consistent basis each reference period is important to compile fit for purpose price indexes.


Goods and Services Tax (GST)

2.11 The Goods and Services Tax (GST) is excluded from all the prices recorded in the PPI because it is deductible on business to business transactions.


Sources of inflationary pressure and price change

2.12 The difference between input and output price indexes is that an input price index is a measure of the price pressures that producers are facing while an output price index is a measure of the price change of the finished good. Producers must consider many other input costs, such as labour and capital costs, when determining if input cost changes can be passed to outputs. They must also consider how the market will respond to an overall price change.

2.13 Outputs can also be inputs further along in the production process, therefore, output price indexes represent a measure of potential price change in further stages of the production process.

2.14 Input and output price indexes reflect price changes resulting from both domestic and international supply and demand. Output price indexes measure prices of domestically produced products, whether sold on domestic or international markets. Input price indexes will include prices for domestically produced and imported products that are used in the production process, such as crude oil and some agricultural produce.


Industry focus

2.15 Australian PPIs represent industries rather than products. An output price index refers to the prices of all products produced by businesses classified to an industry, not just the products primary to that industry. The industry focus of PPIs is an outcome of the 2012 review of the ITPIs and PPIs, as described in Information Paper: Outcome of the Review of the Producer and International Trade Price Indexes, 2012 (cat. no. 6427.0.55.004) and represents a change from the previous approach where PPIs were focused on products primary to an industry. For more information on this review, refer to Chapter 14, or Information Paper: Implementation of the Review of the Producer and International Trade Price Indexes, 2012 (cat. no. 6427.0.55.005).


Scope of price indexes: gross industry basis

2.16 The scope of a producer price index determines which transactions are included in the measure of price change. Indexes may be constructed on a net or gross industry basis. Australian PPIs are compiled on a gross industry basis. This means that the scope of the indexes includes all transactions occurring within an industry and between that industry and other industries. For example, transactions captured for a motor vehicle manufacturing gross industry index includes both the sales of the parts (this includes sales of parts to other businesses within the same industry) and the sales of the finished cars, even though the price change of the parts would be included in the price change of the finished cars.

2.17 An alternative to indexes compiled on a gross industry basis are indexes compiled on a net industry basis. A net industry price index for a specific industry is restricted to transactions outside that industry, so effectively they exclude intra-industry transactions in a manner similar to a set of consolidated accounts of a group of enterprises. Gross industry indexes are conceptually preferred for National Accounts compilation.


Import and export prices

2.18 Import and export price indexes are an important complement to the domestic PPIs. They are used to deflate external trade values to produce international trade volumes. Also, import prices are used to compile producer input indexes because imports are an important contributor to producer costs. Similarly, export prices are used to compile relevant producer output price indexes because exports represent a significant component of producer output.


PURPOSE AND USES OF THE PRODUCER AND INTERNATIONAL TRADE PRICE INDEXES

2.19 The principal purpose of the PPIs and ITPIs is to measure inflation by industry to support the compilation of the Australian National Accounts and the Balance of Payments. This requires that their compilation be on a basis coherent with the frameworks underlying those statistics (the System of National Accounts and the Balance of Payments and International Investment Position Manual Sixth Edition, 2008).

2.20 In the compilation of the Australian National Accounts and the Balance of Payments, components of PPIs and ITPIs are used as deflators to produce Chain Volume Measures.

2.21 The PPI is also used:
  • as an indicator of inflation
  • for a variety of indexation purposes
  • for economic monitoring and comparison by international organisations such as the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF).


Deflator used for Australian National Accounts and Balance of Payments

2.22 PPIs and ITPIs are used to deflate values of a number of components in the Australian National Accounts, including industry inputs and outputs, sales, capital expenditure and inventory data to produce chain volume measures. The deflation process is integral to the compilation of Gross Domestic Product (GDP) and its components. In addition, ITPIs are used in the compilation of Balance of Payments Chain Volume Measures.

2.23 Price deflation is achieved by dividing the current price value for a period (quarter or year) by a measure of the price component (usually in the form of a price index) for the same period. This technique revalues the current price value in the prices of a base period (in the Australian volume measures this is generally the previous year)(footnote 1) .

2.24 Revaluation of the current period values using earlier period prices is defined in the following format:

Formula

Where V refers to value, P refers to price, Q refers to quantity (or in National Accounts terminology, volume), and the superscripts t t-1 refer to current and previous periods respectively.

2.25 More information on the use of price indexes in the production of the Australian National Accounts can be found in Australian System of National Accounts: Concepts, Sources and Methods, 2013 (cat. no. 5216.0) and Information Paper: Australian National Accounts, Introduction of Chain Volume and Price Indexes (cat. no. 5248.0).


Short-term indicator of inflationary trends

2.26 While PPIs are of value in their own right, their use is enhanced when presented in a Stage of Production (SOP) framework. The SOP index provides a transactional flow basis for inflation monitoring. Under the SOP concept, flows of products are categorised according to their economic destination on a sequential basis along the production chain. SOP indexes can be used to study how price change for inputs used to produce final products is passed through to the price of those final products. The data are also used to build models to assess the price pressures that different sectors and industries of the economy are facing, with the aim of assisting private sector business in investment decisions.


Escalation clauses within contracts

2.27 Price indexes are also often used in contracts by businesses and government to adjust payments and/or charges to take account for changes in the prices of products. A PPI offers an independent indicator of the change in prices of the product under contract. Indexation is common in long-term contracts.

2.28 IMPORTANT: While the ABS recognises that the price indexes it produces are used in this way, the ABS neither endorses nor discourages such use. The ABS does not advise, comment or assist in preparing or writing contracts. See Appendix 1 for a discussion on the ABS policy concerning the use of price indexes for contract indexation purposes.


International Organisations

2.29 The ABS provides Australian PPIs and ITPIs to a range of international agencies, including the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) to enable economic monitoring and international comparisons. The provision of PPIs and ITPIs to the IMF also fulfils Australia’s obligations as part of the IMF Special Data Dissemination Standards (SDDS). The SDDS set out criteria concerning the statistics to be produced, their periodicity, release procedures etc. A brief overview of these standards can be found on the IMF Dissemination Standards Bulletin Board.

Footnote 1 The result is, in concept, equivalent to quantity revaluation (i.e. directly revaluing individual products by multiplying their quantity produced or sold in each period by their price in a related base period), since it removes changes in the price component of the current price value, leaving a measure that reflects the volume (or quantity) component valued at the base period prices. <back