Price Indices 101

What are CPI and PPI and How Do They Affect Consumers?

Price Indices 101
August 20, 2014

Price indices represent relative changes in prices for certain goods and services that are calculated to reflect a broader trend. Every month, two of the best-known price indices – the Consumer Price Index (CPI) and the Producer Price Index (PPI) – are compiled and released by the Bureau of Labor Statistics (BLS).

The two indices are somewhat related, since they measure current price changes, but they are looking at fundamentally different spots in the economy. Their names indicate the difference. The PPI focuses on producers of goods and services; the CPI looks at prices from the consumer standpoint.

They both attempt to measure inflation – PPI at the early stages, CPI at the later stages. Economists use the PPI to get a true measure of economic growth by adjusting inflated revenues and the CPI to get a measure of the rise in the overall cost of living.

Even though they are compared over the same time frame, they do not match – the PPI tends to be a partial predictor of the CPI. There are many differences that account for this, but these are the major ones.

  • Which Goods and Services Are Counted – The PPI looks at the overall price picture from producers, including the prices of the raw materials and services they purchase to produce what they sell as well as the prices consumers pay for the end goods and services – thus, the overall PPI is often reported as final demand-intermediate demand (FD-ID). There are many different industry or commodity-specific PPIs that are combined to form the overall PPI numbers. The CPI only considers consumer purchases and is represented by “market baskets” of typical goods and services in eight broad categories: Food and Beverages, Housing, Apparel, Transportation, Medical Care, Recreation, Education/Communication, and Other Goods and Services. The overall CPI, known as the CPI-U, is commonly reported, as is the Core CPI (the overall CPI without food and energy).

    As an economist, you may be more interested in the core CPI because this removes the more volatile food and energy components, giving you a clearer view of inflation. As a consumer, you care about the overall CPI because food and energy make up a large part of your purchases and tend to define your perception of inflation. If you have to pay so much for food and heating oil that you cannot afford a computer or TV, you really do not care that inflation on those electronic items has been held in check.

    Imports are not counted in the PPI since by definition they are not domestically produced (although defining an import these days can be tricky). They are counted in the CPI because imports are part of what consumers buy.

    The PPI does not include as many service industries as the CPI, but it does include investments by the producers (such as changes in the price of their production equipment).

  • Which Aspects of Price are Considered – The PPI does not include sale prices or taxes because these factors do not have any direct benefit to the producers. The CPI does include them because they do affect the prices that consumers pay.

How do these indices affect the consumer?

PPI has an indirect effect on the consumer because it gives some indication of the upcoming prices consumers will pay. For example, if the PPI is higher than the CPI, this suggest that producers costs are rising faster than the prices for those goods – thus profit should be lowered in the short term and prices will rise in the long term.

CPI has a more direct impact because many things are linked to the CPI or a version of it as the means of adjusting for inflation. Social Security benefits, pensions, collective bargaining agreements, food stamps… these and many other income sources are increased for inflation based on the CPI. Income tax brackets, eligibility limits for government programs, and many other government measures are also adjusted via CPI.

In short, if anything is inflation-adjusted, it is a form of the CPI that defines the adjustment.

You may have heard of a potential switch to a chained CPI to adjust government benefits. Chained CPI assumes that you will make choices for less expensive alternatives when they are available – thus your cost of living does not rise as much. That also means your cost of living adjustment is lower using a chained CPI.

As a consumer, what you need to know about PPI and CPI is how they are to be used in any government policy and program that affects you. Take the time to understand which PPI and CPI numbers are being used and why. This allows you to make a more informed vote – which is the only proactive effect you can have.

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