What Are The Consumer Price Index (CPI) and The Producer Price Index (PPI)?

For an economy to grow and become suitable for the comfort of the people within its ecosystem, it is expedient that certain mechanisms and models are observed and put in place. This will enable people to sense the potential situations of the economy and manage it to remain favorable or less toxic. Among the major factors that influence the performance of a market is inflation. Hence, some calculative mechanisms have been created to track the tendencies of inflation in the market so it can be controlled and keep it from outgrowing at the expense of the people’s comfort. Among these mechanisms are the consumer price index (CPI) and the producer price index (PPI).

The consumer price index and the producer price index are key inflationary measures basically adopted to track the change in the price of goods and services in order to manage their impact on the economy.

Consumer Price Index Overview

The consumer price index (CPI) is a price index that measures the average change in the price level of items in a predetermined basket of goods in an economy at a given period of time.

In other words, it is the estimated average of the prices of goods and services that make up the pattern of consumption of a person or household. The consumer price index entails prices of items like foods and beverages, apparel, toiletries, housing services, transportation services, medical services, and lots more.

The CPI is exclusively important to any nation as it uses the derived data to measure the purchasing power of a country’s unit of currency. It interprets an increase in the purchasing power of the currency when the aggregate price level decreases, meanwhile the reverse becomes the case when the aggregate price level increases. Hence, serving as an aid for an economy to control the value of its currency.

The CPI is basically used to indicate the situation of an economy at a given time. It often helps the government to gauge the financial capacity and eligibility level of its people, usually when planning to provide certain infrastructures.

Calculating CPI

The calculation of the CPI is done via a very easy process and formula. It is simply the percentage of the cost of the market basket in a given year over the cost of the market basket in a base year. Hence, here is the formula for calculating the consumer price index for any economy.

CPI = Cost of Market Basket in Base Year / Cost of Market Basket in Given Year​ × 100

In other words, to find the CPI in any year, divide the cost of the market basket in year t by the cost of the same market basket in the base year.

Examples of CPI

The consumer price index is reported in different forms depending on the basis on which the calculation is made. Meanwhile, there are two major forms of CPI which include the consumer price index for all urban consumers, and the consumer price index for urban wage earners and clerical workers.

The consumer price index for all urban consumers is dubbed CPI-U. The rate of consumption of the urban population is often used to weigh the general consumption rate of the public considering that urban residents make the most consumption of goods and services in a nation hence representing about 80% or more of the total consumption.

Another form of consumer price index is the consumer price index for urban wage earners and clerical workers dubbed CPI-W. The CPI-W is measured with a focus on households who earn substantial income from clerical or wage occupations. It basically reflects changes in the costs of benefits paid to those on social security.

Understanding Producer Price Index

The producer price index (PPI) has its focus majorly fixed on production costs and selling price. It measures the average change in the price level influenced by domestic production over time.

Unlike the consumer price index that measures price changes from the perspective of customers, the producer price index measures price changes from the perspective of producers.

It is basically used as a mechanism for adjusting prices in long-term purchasing agreements and is not majorly focused on household items alone. It acts as an external indicator that helps businesses that enter into long-term contracts with suppliers to adjust costs since prices are bound to fluctuate over time.

PPI reports statistical information of production companies usually from the construction, agriculture, manufacturing, and mining industries.

PPI Methodology

The producer price index uses a base number when weighing the average change in the price level of a given period. It then compares the movement against the base number as production increases or decreases.

The basis period number used by PPI is 100. Hence, in the case of a company that has its PPI for a particular month to be estimated as 120. The figure implies that it cost the company 20% more to make their usual productions in that month.

Examples of Producer Price Index

There are several categories of producer price index globally adopted. They include the Industry Level Classification, Commodity-Based Final Demand-Intermediate Demand (FD-ID), and Commodity Classification.

• The industry-based group weighs production price movements at the industry level. It basically tracks the changes in prices received from the output of industry outside it by calculating the industry’s net output.
• The Commodity-Based Final Demand-Intermediate Demand (FD-ID) is used to regroup indexes for goods, services, and construction into sub-product classes. Hence, analyzing the specific buyer of the products.
• The Commodity Classification is focused on combining goods and services by similarity and product make-up.

Trading CPI and PPI

As said earlier, CPI and PPI are both tools used to track inflation and price trends in an economy. They are used to calculate the change in the price of a set of goods and services, hence performing as an indicator of price inflation over time.

Traders can utilize these measurements to gauge the price developments faced by consumers and producers over a specified period of time. Hence, for traders to efficiently leverage these inflationary measures, they can prepare for the release of these statistics by observing the general commodity outlook via the diverse retail sales report.

Key Differences Between PPI and CPI

There are several factors that specifically distinguish the consumer price index from the producer price index. Some of them are:

• Differences in targeted goods and services. PPI focuses on the output of producers while CPI has its focus on household items purchased by consumers.
• PPI and CPI are objected towards different purposes. The producer price index is objected towards calculating the real growth of the economy by adjusting inflated revenue sources. Meanwhile, the consumer price index focuses on calculating the changes in the cost of living by adjusting revenue and expense sources.
• The consumer price index includes sales and taxes in its price statistics, while the producer price index does not include either of them.

Conclusion

When the performance of the market is being traced and predicted, it makes it easy to deploy necessary mechanisms that would keep the market on track. Hence, boosting the positive tendencies of the economy to aid a good living standard for people.

PPI and CPI are important tools that help in making a proper prediction of the outcome of the market. They are undoubtedly very crucial inflationary measures that are highly adopted in most countries of the world.