The Benefits of Using the Producer Price Index

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From its introduction in 1902 until 1978, the Producer Price Index was called the Wholesale Price Index. The Producer Price Index is produced monthly by the Bureau of Labor Statistics and includes a "basket" of goods and services made available for the wholesale market, including finished goods, intermediate goods and raw materials, also called crude commodities. As of 2011, most Producer Price Indexes use a base of 100, representing 1982 production prices. Using the Producer Price Index provides advantages for gauging economic conditions that are not possible with the more familiar Consumer Price Index.

Producer Price Index Versus Consumer Price Index

The Producer Price Index and the Consumer Price Index each have predictive value as indicators of economic conditions. However, the Consumer Price Index focuses on consumer spending and the cost of living, while the Producer Price Index concentrates on the costs of producing goods for the market. For instance, the Producer Price Index drops previous models of items like cars when new models are introduced, while the Consumer Price Index includes both old and new models as long as both are available. In addition, the Consumer Price Index includes sales and excise taxes and distribution costs. The Producer Price Index drops these factors in favor of including the prices of durable goods, which comprise a major factor in production costs.

Inflation

What most people consider inflation or deflation relates to the increase or fall of the cost of consumer goods. The Producer Price Index is capable of measuring true growth and reduction of output, while the Consumer Price Index is more reflective of supply and demand. The Producer Price Index can be used to avoid the effect of consumer market inflation on price change measurements. Instead, the Producer Price Index measures inflation by the increase or reduction of the prices of goods when they leave the manufacturing plant.

Foreshadow Retail Price Changes

By definition, the Consumer Price Index reflects prices of goods once they have made their way to the general marketplace. Because the Producer Price Index measures the price of goods before they reach the consumer, it can have predictive value concerning future retail prices. However, it is impossible to make a one-for-one comparison between the Producer Price Index and future retail prices, because producers are not always able to pass production and other costs along to consumers.

Contract Negotiations

Many long-term sales contracts include escalation clauses to account for the effects of inflation and market changes. The Producer Price Index can assist in the negotiation of escalation clauses because it represents an objective measurement of price changes. The Producer Price Index is also widely accepted by business owners, accountants and statisticians as a legitimate basis of measurement.

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