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Producer Price Index: Definition & Formula

Producer Price Index: Definition & Formula
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  • 0:00 Producer Price Index
  • 0:34 Elements of the…
  • 1:48 Calculating the PPI
  • 3:50 Predicting Inflation…
  • 6:06 Lesson Summary
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Lesson Transcript
Instructor: Lucinda Stanley

Lucinda has taught business and information technology and has a PhD in Education.

In this lesson, you will become familiar with the Producer Price Index (PPI). You will see how the PPI can predict increases in consumer prices, and learn how to calculate a basic PPI before using it to predict inflation.

Producer Price Index

What do economists look at to determine that inflation is at an all-time high or that the Consumer Price Index is going to increase? One of the tools economists use is the Producer Price Index (PPI).

The PPI compares the average costs of a standard set of products, often called a basket of goods, over time at the wholesale level. Wholesale, meaning, the cost before a product gets to the consumer. As a matter of fact, the PPI used to be known as the Wholesale Price Index.

Elements of the Producer Price Index

The PPI is published by the Bureau of Labor and Statistics (BLS) once a month. It is a sampling of wholesale prices from a variety of industries and is broken down into three categories: industry-based, commodity-based, and stage-of-processing-based. Some of the industry-based industries include integrated circuits and microprocessors. Some of the commodity-based products include computer terminals and monitors. Stage-of-processing-based indices look at products that are not yet in their final consumer form. The PPI removes food and energy industries from the basket of goods because they are the most volatile, meaning that their prices are most likely to fluctuate a great deal and therefore, are not good indicators for overall trends in the economy.

This graph is an example of Australia's PPI for 1996-2013 for construction goods.

Australia PPI Graph for Construction

The PPI is plotted on the graph, and a trend line is created over the points. It is clear that the PPI has been on an increase since 1996, although the increase is not as dramatic beginning in 2008, where the line becomes somewhat more flat.

Calculating the PPI

The PPI is calculated from a baseline, meaning a year whose cost of goods is set at 100. December 1982 is the baseline for most industries' basket of goods. Suppose the cost of the basket of goods for the PPI in 1982 was $6,359. This amount becomes the baseline and is set equal to 100%. This makes calculation and comparison across the years easier.

The basic formula for calculating the PPI requires basic information such as the quantity of the product at the start date, the selling price at the start date, and the selling price at the end date.

(Quantity * Original selling price * (New selling price / Original selling price) / Quantity) * 100

Let's look at a simplified example of how PPI is calculated. Let's say we have an industry that has only one product, a Snarf. The industry reports information about the quantity of Snarfs they had on hand at the beginning of the period (2000), the original selling price ($2.00), and the ending selling price ($2.50).

We plug our Snarf numbers into the formula:

(2000 * 2.00 * (2.50/2.00)/2000) * 100

Snarf PPI Calculation

Broken down it looks like this:

New selling price/Original selling price: 2.50/2.00 = 1.25.

Quantity * Original price * the change in price calculated above: 2000 * 2.00 * 1.25 = 5000

Divide that number by the original quantity: 5000/2000 = 2.50

Multiply the new number times the base of 100: 2.5 * 100 = 250

Snarf PPI calculation: 250 is the PPI for the Snarf industry. This number is calculated into the PPIs for every industry to arrive at a national PPI which economists use to predict inflation.

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