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Conceptual basis of the producers price index

This chapter describes key concepts behind the producers price index (PPI), including the two main types of indexes (outputs and inputs), pricing, weighting, and reference periods.

Topics covered in this chapter are:

What the PPI measures

The PPI measures changes in prices for the supply (outputs) and use (inputs) of goods and services by New Zealand’s productive sector. It measures changes in the prices of outputs that generate operating income, and inputs that incur operating expense.

The PPI does not include prices for items related to capitalised expenditure, non-operating income, financing costs, or employee compensation. Nor does it cover depreciation, or income related to property ownership when this is not the normal source of operating income.

Output indexes

The PPI output indexes measure changes in the prices received by businesses for the goods and services they produce. The definition of output is consistent with output as defined by the international System of National Accounts 2008 (SNA08).

The prices we use to calculate the output indexes are conceptually those prices received by the producer for the good or service. The output indexes cover:

  • sales of primary products
  • sales of manufactured goods
  • revenue from renting and leasing
  • provision of services
  • capital work undertaken by the producer’s own employees
  • margins on goods purchased for resale.

While conceptually the above items are included in the output indexes, we do not directly price capital work undertaken by the producer’s own employees or margins on goods purchased for resale. These transactions are included only in the weights of the PPI.

Excluded from the output indexes are:

  • interest and dividends
  • royalties and patent fees
  • insurance payouts
  • government cash grants
  • excise taxes, GST, and other indirect taxes.

Input indexes

The PPI input indexes measure price changes in the current costs of production within the economy. The definition of current costs of production is consistent with intermediate consumption as defined in the SNA08.

Intermediate consumption within the SNA08 is equivalent to the goods and services used up in the production process by a business in creating its output. However, it excludes expenditure on both capital and labour.

The input indexes cover:

  • purchase of materials
  • fuels and electricity
  • transport and communication
  • commission and contract services
  • rent and lease of land, buildings, vehicles, and machinery
  • business services
  • insurance premiums less claims
  • financial intermediation services.

Excluded from the input indexes are:

  • wages and salaries
  • capital expenditure
  • ACC levies and other government charges
  • local authority rates
  • royalties and patent fees
  • bad debts
  • donations
  • depreciation and amortisation.

Pricing concepts

In the PPI we use ‘basic’ prices collected directly from producers to compile the output indexes. The basic price is the price the goods or service producer actually receives from the purchaser of the goods or service, minus any tax payable, and plus any subsidy received on that unit as a result of its production or sale. Sometimes we use the producer’s prices when the basic price is not readily available. The producer’s price is the basic price, plus any non-deductible tax on products paid by the producer, less any subsidies on products received by the producer.

Prices we use in the input indexes are a mix of output proxy prices (at basic or producer’s prices) and a few directly collected input prices (at purchaser’s prices). Purchaser’s prices exclude deductible taxes on products (eg GST), but include any non-deductible product taxes (if they exist) and any trade margins or transportation charges. We use output proxy prices under the assumption that the trade and transport margins represent a constant proportion of the purchaser’s price over time, or that they are such a small proportion of the purchaser’s price that changes in the margin proportions are unlikely to have any substantial effect.

Table 1
Example: PPI pricing basis

  NZ$   
Basic price  105 Ideal output price 
+ non-deductible taxes on product 
- subsidies on product
 0
(15)
 
= Producer's price  90  
+ transport and trade margins paid by purchaser  10  
= Purchaser's price  100  Ideal input price

GST is excluded when measuring input prices for most industries. Our assumption is those involved in activities in these industries are businesses that provide ‘taxable supply’. GST paid on intermediate consumption is recoverable under the GST credit offset system and is therefore not part of the ultimate input price.

However some industries are exceptions to this assumption. Banking and finance, life insurance, and residential property operation industries provide some ‘exempt supply’ activities, whereby these activities are GST exempt. The exempt supply activities include provision of life insurance, financial services, and the rental of residential properties. Therefore, for these activities, input indexes are calculated inclusive of GST.

The measurement of change in the price of inputs for the owner-occupied dwellings industry is also calculated inclusive of GST. This industry comprises households that own their own homes and notionally rent them back to themselves. It includes private dwellings such as houses, flats, and farm houses, if they are owned by the people who occupy them. This is calculated inclusive of GST because householders are not able to claim back GST (in their capacity as final consumers) on their domestic expenditure.

Weighting indexes

We have always produced the output indexes using gross weights, which means the values of all outputs within the same industrial classification category are in scope for weighting and pricing. This ensures the indexes completely cover the targeted industries.

National accounts require gross weighting to deflate gross flows of industry income and expenditure, as this is done in national accounts using NZSIOC level 4 PPI indexes. However, when using gross weighted indexes, multiple counting of price change can occur as products flow through the different production processes – this occurs where the output of an enterprise is used as the input into another enterprise within the same PPI industry. Therefore, the double counting of price movements makes the indexes less useful for inflation monitoring.

Reweighting indexes

We periodically review the PPI indexes on a rolling cycle to ensure the:

  • scope and coverage of the indexes continue to meet the needs of customers
  • structure of the indexes reflects the up-to-date activities of the industry concerned
  • respondent load on surveyed businesses is minimised
  • weights we use continue to be representative of the industry concerned.

We annually reweight the PPI industry and commodity weights, using detailed product information sourced from the supply and use reconciliation undertaken annually in the national accounts. The weights associated with the commodities, and the weights attached to each industry, are therefore annually chain-linked. This reflects changes in economy-wide income and expenditure in the mix of products and the mix of industries. The industry specific baskets and weights are provided in the industry and commodity by industry weights tables.

We undertake a rolling review of industries to refresh the NA06CC commodity weights which feed into our national accounts supply and use tables. The same reviews are used to update the prices feeding into the representative commodities, and the weights of the representative commodities feeding into the NA06CC commodities.

See Rolling review of the producers price index for more information 

Reference periods

Weight reference period

The weight reference period of an index refers to the year or years from which the weighting data was derived. We introduce updated PPI weights each March quarter. For example, the March 2015 quarter introduced an updated weight reference period of the year to March 2012. The time lag is due to the time it takes our National Accounts team to complete the annual supply and use reconciliation.

Price reference period

The price reference period is the quarter that the latest quarter's prices are compared with in order to calculate indexes. As part of updating the weight reference period (see above), we update the price reference period to the December quarter of the previous year. For example, for the updated weights applied in the March 2015 quarter (which are used to weight price movements from the December 2014 quarter to the March, June, September, and December 2015 quarters), the price reference period was the December 2014 quarter.

Index reference period

The index reference period of an index is the time period (ie month or quarter) used for comparing indexes. This is where we set the index number to 1000. Changing the index reference period is a matter of convenience and does not change the meaning of the index. The percentage change between each period is unaltered by this process.

Customers may wish to re-express an index in terms of a common index reference period to allow comparison of series with differing index weighting reference periods.

We do not regularly change our index reference periods. Historically this has only happened when we have changed to a new industry classification. As from the March 2011 quarter, the index reference period of the PPI indexes was changed to the December 2010 quarter (=1000).

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