Producer Price Index Manual: Theory and Practice ... - METAC

Producer Price Index Manual
contribute much more to the fit of the model. A
second, qualitative criterion is that the included
characteristics be meaningful to the participants in
the market for the product.
B.2 Conceptual issues
7.43 Recalling Chapter 2, a PPI is an index designed
to measure the average change in the price
of goods and services as they leave the place of
production (output prices at basic values) or as
they enter the production process (input prices at
purchaser’s values). There are PPIs for total output
and intermediate input. There are also PPIs for a
range of net output concepts, at different levels of
aggregation, representing different stages of production:
primary products, intermediate goods, and
finished goods. Changes over time in the prices of
inputs are an indicator of potential inflation, which
will, to some degree, feed through to output prices
as output inflation. Section B.2.1 discusses the
output price index. It focuses on the general quality
adjustment problem for output price indices and
the restrictive assumptions that have to be maintained
to use the often-favored resource cost approach
to quality adjustment. The principles relating
to an input price index follow in Section B.2.2.
It outlines the quality adjustment problem for input
price indices and the restrictive assumptions that
have to be maintained to use the often-favored user
value approach to quality adjustment. The discussion
continues in Section B.2.3 with a brief introduction
to two problems associated with resource
cost and user value approaches. The first, in Section
B.2.4, occurs when technology substantially
changes and fixed-input output indices make little
sense for valuing higher quality products produced
at much lower unit cost. The second is the reconciliation
problem in national accounts at constant
prices referred to above, a problem that leads the
Manual to recommendations on a unified valuation
system in Section B.2.5.
B.2.1 Fixed-input output price index
7.44 In this Manual, the principal conceptual
basis for the output PPI is the fixed-input output
price index (FIOPI). The output PPI thus aims to
measure an output price index constructed on the
assumption that inputs and technology are fixed. 4
4 See Chapter 17, Section B.1, for more on this conceptual
framework.
Chapter 18 defines the FIOPI as a ratio of revenue
functions. The revenue function of an establishment
expresses the value of its output as a function
of the prices it receives and the quantities of inputs
required to produce the output. It recognizes that
only a finite number of varieties or products are
producible at any given time but also grants that
for given inputs and technology, there may be a
continuum of designs from which producers select
this finite number of products. Hence, in response
to changes in preferences or the technologies of
producers using a given establishment’s output,
there may be different sets of products produced
from period to period from a given set of inputs
and technology.
7.45 Compilers and even price index theorists
are used to thinking in the narrower framework
comparing the prices of exactly the same things
from period to period. 5 For example, they would
measure a shirtmaker’s price change on the assumption
that the cutting, sewing, folding, packaging,
and so forth were all undertaken in the same
way from the same labor, capital, and material inputs
in the two periods being compared. If the
revenue increased by 5 percent, given that everything
else remained the same, then the output price
also increased by 5 percent. If such things do not
change, then a measure of a pure price change results.
7.46 Even if technology and inputs remain the
same, the way things are produced and sold may
change. For example, the shirtmaker may start improving
the quality of his or her shirts by using extra
cloth and more stitching using the same machinery.
The price basis or product description underlying
this comparison has changed within a
given technological framework. A direct comparison
of successive months of shirt prices includes,
in this case, not only the effects on revenue from
price changes but also changes in product characteristics
and quality. To include the increase in
revenue resulting from improved quality would be
to misrepresent price change—to bias the index
upward. Prices would not, in fact, be rising as fast
as indicated by such an unadjusted index.
7.47 A pure price relative for a product fixes
the product description or price basis by definition.
For the price basis not to change, the product’s ob-
5 See, for example, Gerduk, Gousen, and Monk (1986).
148