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

1. An Introduction to PPI Methodology
If one observation is zero, the geometric mean is
zero. The Jevons is sensitive to extreme falls in
prices, and it may be necessary to impose upper and
lower bounds on the individual price relatives when
using the Jevons.
I.5 The economic approach to elementary
indices
1.151 The economic approach, explained in Section
F of Chapter 20, seeks to take account of the
economic behavior of producers and their economic
circumstances. Price differences may be observed at
the same point of time for two quite different reasons.
• Exactly the same product may be sold by different
categories of producers at different
prices.
• The sampled products are not exactly the same.
The different prices reflect differences in quality.
•
Both phenomena may occur at the same time.
1.152 Pure price differences can occur when the
products sold at different prices are exactly the
same. Pure price differences imply differing technologies
or market imperfections of some kind,
such as local monopolies, price discrimination, consumer
or producer ignorance, or rationing. If all
consumers had equal access, were well informed,
and were free to choose, and all producers produced
using the same technologies in price-taking markets,
all sales would be made at a single price, the
lowest on offer.
1.153 On the other hand, if markets were perfect,
producers would be prepared to supply at different
prices only if the products were qualitatively different.
Included in the term “product” are the terms
and conditions surrounding the sale, including the
level of service and convenience. It is tempting to
assume, therefore, that the mere existence of different
prices implies that the products must be qualitatively
different in some way. For example, even
units of the same physically homogeneous product
produced at different locations or times of the day
may be qualitatively different from an economic
viewpoint. For example, a service supplied in the
center of town in the evening may carry a price
premium, due to higher labor costs, even though it
is essentially the same service. In this instance the
higher price is arguably not a pure price difference.
However, the relative prices in different establishments
do not necessarily have to match differences
in producer inputs and technologies and consumers’
preferences and may be, in part, pure price differences.
In practice, almost all markets are imperfect
to some extent, and pure price differences cannot be
assumed away a priori.
1.154 If there is only a single homogeneous
product produced by an establishment on a “normal”
day, the price differences must be pure. The
average price is equal to the unit value, defined as
the total value sold divided by the total quantity.
The unit value is a quantity-weighted average of the
different prices at which the product is sold. It
changes in response to changes in the mix of quantities
sold at different prices as well as to any
changes in the prices themselves. In practice, however,
the change in the unit value has to be estimated
from a sample of prices only. Unit values exist
at two levels. The first is for a production run i at
the establishment level where a batch of, say, q i
products may be sold for revenue p i q i , the price recorded
being the unit value. There may be more
than one production run at different batch sizes, and
the unit values may vary with batch size. The recorded
“price” for these products may then be the
revenue from several batches divided by the quantity
supplied, Σ p i q i / q i . If the mix of batch sizes
varies over time, then there will be unit-value bias
when dividing the unit value in one period by that
in a preceding period. The second aggregation of
unit values is across establishments producing the
same commodity. Again, any difference in the relative
quantities sold from different establishments
will lead to unit-value bias if the commodities are
not strictly homogeneous.
I.5.1
Sets of homogeneous products
1.155 The economic approach views the products
as if they were a sample from a basket produced by
a group of rational, revenue-maximizing producers.
One critical factor is how much product variation
there is within an elementary aggregate, bearing in
mind that it should be as narrowly defined as possible,
possibly even consisting of a set of homogeneous
products.
1.156 If the sampled products are all identical,
the observed price differences must be due to establishments
using different production technologies
and market imperfections such as price discrimina-
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