Use of price indexes in National Accounts component aggregates
In the Australian economy, millions of economic transactions take place every day involving the production and sale of goods and services (products). The monetary value of each of these transactions is a product of the quantity produced or sold at a price per unit. In a particular period, the total value of all transactions taking place in an economy is simply the sum of the individual transaction values in that period. This is referred to as the current price value.
The calculation of Gross Domestic Product (GDP) using the income approach is compiled only in current prices and does not directly utilise price indexes; proxy volume estimates are produced for this approach using the implicit price deflator from the expenditure account (the implicit price deflator is detailed in Chapter 4 General Compilation Methodology, National Accounts and Balance of Payments - Derived Measures).
The suite of ABS Price Indexes used in compiling the Australian National Accounts are not the only mechanisms used to derive volume measures. Other techniques include direct volume measurement and the use of quantity revaluation (i.e. multiplying current period quantities by a reference period unit value) in calculating volumes of homogeneous export products such as wheat and coal). Quantity revaluation can be seen as conceptually consistent with the action of deflation using average unit values as opposed to price indexes. Average unit values can differ to equivalent price indexes due to changes in quality and composition.
In some circumstances price indexes are combined to produce aggregate deflators (for example, combining a Wage Price Index component with a Producer Price Index component). These composite measures are required when the value aggregate from the Australian National Accounts has a broader scope than the contributing price indexes.
For a more detailed explanation of these concepts, see Australian System of National Accounts: Concepts, Sources and Methods.
‘Gross Industry’ versus ‘Net Industry’ approach to defining scope
The compilation of Australian National Accounts is conceptually done on a ‘Gross Industry Basis’, and this means that the scope of data collection includes all transactions that occur within an industry and transactions between that industry and other intersecting 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.
An alternative approach to the ‘Gross Industry Basis’ approach is the ‘Net Industry Approach’ which restricts the scope of collection to transactions that occur within the industry, and in effect, exclude intra-industry transactions in a manner similar to a set of consolidated accounts of a group of enterprises.
The PPIs are recorded on a ‘Gross Industry Basis’ to ensure consistency with the Australian System of National Accounts compilation processes.
Input and Output price indexes
Input price indexes
The valuation basis for 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.).
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 the Producer Price Indexes.
Output price indexes
The preferred valuation basis for the transactions covered by an output price index is at basic prices, although purchasers’ 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 are:
- basic prices are prices before taxes on products are added and subsidies on products are subtracted.
- purchasers’ 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.).
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.
The suite of ABS output price indexes measure the prices received by producers irrespective of whether their products are sold on the domestic market or as exports.
Import and export prices
Both the Import Price Index and the Export Price Index are valued using a free on board (f.o.b.) pricing basis. The value of products measured on an f.o.b. basis includes all production and other costs incurred up until the products are placed on board the international carrier for either export. For imports, freight and insurance charges involved in shipping goods from foreign to Australian ports are excluded from the prices used in the index, as are Australian import duties and taxes. Similarly, exports are priced on a f.o.b. basis at the main Australian ports of export. Exports are exempt from taxes on products.
While coverage of goods producing industries is relatively comprehensive, the coverage of services industries is being progressively improved for both the Producer and International Trade Price Indexes. The expansion of new and emerging industries in both the Producer and International Trade Price Indexes is a key objective for the ABS to ensure both publications continue to effectively support the compilation of Australian National Accounts and Balance of Payments.
Non-market goods and services
Non-market activities involve products produced by non-profit institutions serving households (NPISHs) or government that are supplied free, or at prices that are not economically significant, to other institutional units or the community as a whole. These comprise both non-market services provided to individuals (such as health and education services) where a specific transaction can be identified but there is no economically significant price; as well as collective services (such as public administration and defence) where no individual transactions can be identified as the services are consumed by the entire population, indirectly, continuously and largely involuntarily. For more information on non-market activities refer to the Australian System of National Accounts: Concepts, Sources and Methods.
Non-market activities have been historically excluded from the scope of Producer Price Indexes due to the fact that no market transaction takes place and therefore no change in transaction price can be measured. For this reason, most countries define non-market activities as falling outside the scope of Producer Price Indexes.
The Information Paper: Outcome of the Review of the Producer and International Trade Price Indexes, 2012 states that the basis of PPIs and ITPIs are to capture price movements for all products represented in the Input-Output (I-O) framework. Therefore, non-market activities should be captured. Where the non-market activity resembles a market activity (for example, education), the market price index may serve as a proxy for a non-market price movement
However, some non-market activity where market equivalents are unavailable (for example, national defence) is valued at production cost, and there is no basis for constructing an explicit price index. The ABS will investigate how to reflect products such as non-market prices (as represented in the Australian National Accounts) within the Producer Price Index release.
Classifications are a set of defined groupings or categories, based on common relationships, into which all members of statistical units can be divided or arranged. These groupings or categories can be ordered systematically and must be mutually exclusive and exhaustive.
The classification structure forms the index structure and determines which products from which industries of the economy are needed to construct price indexes. Further, the classification serves as the basic language allowing sources of value data and price indexes to have a direct concordance.
Classifications enable an exact definition of which products are to be included in an index, and provide a meaningful and cohesive structure for reporting on price movements for different subsets of the price basket.
The ABS uses many international and local classification systems.
In the price index context, the availability of value data will dictate the lowest level of detail that might be possible. Although a classification may be conceived according to economic theory or user requirements using a top-down approach, in application the ABS collects data about individual products and then aggregates them according to the classification structure (i.e. a bottom-up approach).
In application, products used in the compilation of the Producer and International Trade Price Indexes can be classified according to more than one classification structure.
Please refer to Chapter 2, General Methodology of this release for detailed information on the current classification systems used in the compilation of the Producer and International Trade Price Indexes.
Deflator used for Australian National Accounts and Balance of Payments
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.
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)¹.
Revaluation of the current period values using earlier period prices is defined in the following format:
Where \(V\) refers to value, \(P\) refers to price, \(Q\) refers to quantity (or in National Accounts terminology, volume), and the superscripts \(t \space t-1\) refer to current and previous periods respectively.
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 and Information Paper: Australian National Accounts, Introduction of Chain Volume and Price Indexes.
Short-term indicator of inflationary trends
While PPIs are of value in their own right, their use is enhanced when presented in the Final Demand framework. Final Demand measures the price change of products (goods and services) consumed with no further processing. For example, sugar cane is a preliminary product and used as an input into the production of raw sugar. In turn raw sugar is an intermediate product which is then used to produce the final product, refined sugar. Final Demand captures final products destined for final consumption, with no further processing.
An Illustration of the Final demand is presented below. The two examples show the three stages: preliminary, intermediate, and final for sugar and bread.
Escalation clauses within contracts
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.
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.
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.