Producer price indexes - Transcript
Welcome to the Statistics Canada Training Institute. Today, we will explore producer price indexes— what they are, how they are made and what they are used for.
To understand producer price indexes, you first need to know what producer prices are and what a price index is. Producer prices are the prices at which businesses sell their products or services to others (for example, the government, consumers or other businesses).
Although value-added taxes generally apply to the sale of these products, they are excluded from producer prices. For example, a retailer sells gasoline to a consumer for $1.32 per litre, plus tax. The tax on the litre sold is not part of the amount the retailer receives.
There are two main uses for producer price indexes. One is to adjust business or government contracts to inflation. The other is to calculate the real value of economic output by adjusting for price changes. In other words, price indexes are used to measure real gross domestic product (GDP). This is why there are many producer price indexes, covering a wide range of economic activities, such as manufacturing, construction, professional services, distributive trades and financial services.
To illustrate the various producer price indexes present in the production process, let's take a look at the value chain for a house. A value chain is a series of activities that each adds value to the end product or service. These activities include labour, materials, goods, services and technology (or the so-called "factors of production"). Each step in the value chain needs to be measured to assess its macroeconomic impact, which is where producer price indexes come in. When you buy a new house, you (the consumer) see the end product. However, many activities go into planning, building and purchasing this house:
The first step in building a house is to extract the raw materials used to build it. A wide variety of materials are needed, such as lumber, steel, concrete, and glass. Let's take a closer look at the value chain of lumber.
First, logs are harvested by forestry companies. The price for the raw logs is captured in the Raw Materials Price Index. This index includes all costs producers incur to bring a log to the factory gate—for example, transportation charges, customs duties and subsidies, if applicable.
The next step in this value chain is the manufacturing process, during which the raw logs are turned into lumber. The price of this activity is captured in the Industrial Product Price Index and is the price of goods sold at the factory gate. As a result, the prices covered by this index are not what a purchaser pays, but what the producer receives. This excludes all indirect taxes, such as sales taxes and tariffs, as these do not go towards the factors of production.
The finished lumber leaves the factory and needs to be transported to the wholesaler. The transportation process is an economic activity that creates a service within the value chain. If the lumber is transported by truck, the price for this transportation service is captured in the For-hire Motor Carrier Freight Services Price Index. This industry is a vital part of the Canadian economy and the services it provides are crucial to the effective and efficient flow of goods.
Wholesalers store and distribute the lumber to retail stores or directly to the end user. The price for this service is captured in the Wholesale Services Price Index. The price of the wholesale service is defined as the margin price of what the wholesaler receives for their service. The margin price is calculated as the difference between the selling price and the purchase price of the wholesale service being measured.
Now it's time to transform the lumber into a house. Before construction can begin, the house needs to be designed by an architect and structural engineer. The architects and engineers who do this work charge for their services. The Architectural, Engineering and Related Services Price Index captures information on the prices of architectural, landscape architecture, engineering, and geophysical and non-geophysical surveying and mapping services. In this case, an architect would price out a standard contract for their services.
Once the house plans and specifications have been drawn up, a general contractor is selected to build the house. The changes in the price the contractor charges are measured in the Residential Building Construction Price Index. This type of index measures the change over time in the prices contractors charge for building various types of residences (for example, bungalows, two-storey houses, townhouses, high-rise and low-rise apartment buildings). The contractor's price includes the value of all materials, labour, equipment, overhead overhead and profit involved in the construction of a new building.
Towards the end of the value chain is the final product: a brand new house. The contractor or builder sells the house to a consumer. The change in this sale price is captured in the New Housing Price Index. This index measures changes over time in the contractors' sale prices of new residential houses, where detailed specifications pertaining to each house remain the same between two consecutive months.
House purchases are normally financed by a mortgage. The change in the price of this service is measured in the New Lending Services Price Index. This index measures monthly price changes over time for new lending services. Prices represent the difference between annual percentage rates for new loan products and weighted averages of yields on financial market instruments.
Now that we have demonstrated how producer prices span the entire economy and talked about some uses of these indexes, let's discuss how indexes are built. Much like our brand new house, indexes have many layers and components.
To build an index, we need to identify a basket of goods and services that businesses in Canada might sell. We do this because it's impossible to capture the prices of every good and service a business produces. Instead, we track the selling prices of their most representative goods and services over time. To measure pure price change, it is important to keep the contents of the basket fixed over time. The basket differs depending on which part of the value chain is being measured. For example, the For-hire Motor Carrier Freight Services Price Index's basket contains the type of shipment and route travelled, whereas the basket for a residential building construction price index contains components such as building materials, labour and overhead.
Each item in the basket receives a relative importance, or basket weight, that represents its share in the total value of all goods or services in that particular sector of the economy. For example, motorized and recreational vehicles represent a larger share of the total value than meat, fish and dairy products; therefore, motorized and recreational vehicles receive a larger weight than meat, fish and dairy products in the Industrial Product Price Index basket.
Basket contents and their weights represent the production patterns of Canadian businesses, which change over time. For example, years ago manufacturers produced cars with cassette players. Today, they produce cars with Bluetooth or even electric cars. Updating the basket regularly ensures that the index remains representative of the range of goods and services produced in Canada.
With a practically infinite selection of goods and services, evaluating the basket price requires a large-scale coordinated effort by Statistics Canada. Most of the price quotes used to calculate producer price indexes are collected using surveys of Canadian producers. Other prices are obtained from non-survey sources, such as the Internet.
Price change measurement
Now that we have obtained prices for our basket of goods and services, we can measure the change in price from one period to another. We want to measure pure price change, which is the change in price from inflation alone, so the price is collected for the identical product or service over time. Changes in the quantity or quality of collected products or services are taken into account. For example, say a business produced a pivot chair with no arms and sold it for $100, then started producing only pivot chairs with arms that sold for $120. Even though the selling price has increased, adjustments are made for these quality changes to show no change.
Thank you for joining us on this tutorial of Value Chains and Producer Price Indexes