Source: Image of Business Cycle created by Kate Eskra
Hi. Welcome to macroeconomics. This is Kate. This tutorial is on the PPI, CPI, or Deflator. As always, my key terms are in red, and examples are in green. So in this tutorial, we'll talk about the difference between the CPI and the PPI, and I'll show you how they're calculated. We'll also discuss how these measures are used to assess the macroeconomy.
So you've seen a business cycle before, and we know that it's normal for the economy to go through periods of growth and contraction. Along this business cycle, most people are generally concerned about things like the unemployment rate and inflation. Those are kind of the two most common that people listen to. In this tutorial, we're focusing then on inflation.
So the Bureau of Labor Statistics, or BLS, is who measures the rate of inflation in our economy. And inflation means an increase in the overall price level. And this happens when many prices increase at the same time. This is not just the price of gas going up or down this week. OK? This is an increase in the overall price level.
So inflation is measured from two different perspectives. One, from consumers' perspectives, and that's the CPI, or Consumer Price Index. Two, from the producer's perspective. And that's the PPI, or Producer Price Index. Let's talk about the Consumer Price Index first.
So the CPI is the consumer price index, and this reflects changing prices for a fixed bucket of goods and services. And economists are going to use these price indexes, or measurements, that show how the average price of a standard group of goods changes over time. And the most common one is the CPI. So it would be impossible to literally measure, in a timely manner, the price of absolutely everything in the economy.
So what they do is they use a bundle of goods that's meant to represent the market basket purchased monthly by the typical urban consumer. So I just gave you some examples here of some of the categories in this market basket. Food and drinks, housing, apparel and upkeep, transportation, medical care, entertainment, education and communication, and then this category of other. And I gave you some examples. For example, food and drinks, we would include things that most people would be purchasing in any given month. So you can take a look at that if you're interested.
So the goods and quantity consumed in this basket are held constant from one period to another. So here, it's the quantity that we're holding constant. And what we let vary are the prices. And so when we allow prices to vary, and we use prices that are currently seen in the market, that's known as nominal. So the idea is that the CPI then captures price changes for a standard group of goods.
And you can see, if you want to go to this website here, this is the Bureau of Labor Statistics website. If you do the /CPI, you will be able to access their most current released report. And so this just came-- I just wanted you to have an example as to how this is phrased and what it looks like.
So from the January 2014 report-- now keep in mind, this is reporting on what happened in December. So it says here the consumer price index for all urban consumers increased 0.3 percent in December on a seasonally adjusted basis. Over the last 12 months, the all Items index increased 1.5% percent before seasonal adjustment. So that's how it's worded. You can learn all about how the CPI is measured, all the details of it at that website. It's very informative.
Let's talk about the PPI. The PPI is the producer price index. And this reflects price movement for raw materials, intermediate, and then final good production. So this is from the producer's perspective. So the idea behind measuring the PPI is to see if there's one stage of the production process that media is the cause for price changes in the market. So because that's what we're trying to figure out, the PPI measures wholesale price changes in three different categories.
First of all, it measures price changes for crude goods. So this is the initial inputs in the production process of a good. Then they look at intermediate goods. Intermediate goods are components used to make the end product. And then finally, finished goods. So goods that are produced and ready to be distributed and sold.
Again, I did the same thing here as I did with the CPI. This is all you would have to do, is change the C to a P here. And the Bureau of Labor Statistics also publishes this report. So this one comes from the January 2014 report. And you can see that I highlighted in green the examples of finished goods, intermediate goods, and crude goods. Because they're giving you the breakdown of what happened.
So you can see in December, apparently, of 2013, the PPI for finished goods went up 0.4%. At the earlier stages of processing, the intermediate goods one rose 0.6% and crude goods actually climbed 2.4% in that period. So how is it that CPI and PPI are used? Well, both are used to measure price changes or inflation. But they're just from different perspectives. Like we've said, CPI is from consumer's perspective, and PPI is from that of the producers.
So we could do it with either one, I'm just using the CPI here. So to calculate the inflation rate from one period to the next, you just use the CPI or PPI in two different periods. So here, I didn't list years. I'm just saying CPI2 minus CPI1 divided by CPI1 will give us a rate of inflation. That sometimes is confusing, so let's use an example.
If the CPI in year one-- I made it really easy-- was 100, the CPI in year two was 103, well, what would you do? You would take the change. So it would be 103 minus 100 divided by 100, and that would give you 0.03, or show that there was 3% inflation from CPI1 to CPI2.
So the CPI and PPI are used as economic indicators in our economy. And first of all, it's interesting to keep in mind that the PPI generally is relatively good at predicting what's going to happen then in the CPI. Because that's what the producers are experiencing, and then likely they're going to adjust prices accordingly after that. So because this is a good predictor of what's going to happen in the CPI, and it breaks it down on the way that it does, it's used extensively by investors actually. They use the PPI more than the CPI.
The CPI is definitely considered a lagging indicator, because it takes some time for prices to adjust to economic conditions. So as businesses start to see a drop off in demand for their products, they eventually lower prices. As businesses see an increase in demand, they will raise prices.
So macroeconomists are concerned with inflation and deflation, absolutely. So they definitely closely monitor both of these indicators. And that's because rapid inflation really decreases our purchasing power and can mean that the economy is growing too quickly. Whereas deflation-- although it's a misconception that some people think that would be a good thing, because prices are going down-- can actually be very problematic. As people are holding off purchases, and that is not good for the macroeconomy, and can actually be a sign that we're in a recession.
So in this tutorial, we talked about the difference between the CPI and PPI, and I showed you how both are measured briefly. And we also looked at how the CPI and PPI are used to assess the macroeconomy. Thanks so much for listening. Have a great day.
Consumer Price Index reflects changing price for a fixed bucket of goods and services.
Producer Price Index reflects price movement for raw materials, intermediate and final good production.