CNBC Explains

Producer Price Index: CNBC Explains

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The producer price index is a trio of indexes that measure the change in the selling prices — or wholesale prices — received by domestic producers for their output. The PPI is a key economic measurement especially when it comes to inflation.

Let's break this down and make it clearer.

First, wholesale prices are the prices manufacturers or producers charge each other when selling their products for further manufacturing. They are also the prices a retailer pays -- say, a grocery store -- for buying the products, which are then sold to the consumer at usually a higher price, or the retail price. This part is the finished goods part of the PPI, as we'll see in a bit.

Now, let's look at the three areas that make up the PPI. The prices included in the PPI are from the first transaction for many products and some services.

  • Commodity Index: This shows the average price change from the previous month for commodities such as energy, coal, crude oil and steel scrap.

  • Stage of Processing Index: Goods here have been manufactured at some level, but will be sold to other manufacturers to create the finished good. Some examples of SOP products are lumber, steel, cotton and diesel fuel.

  • Industry Index: Final stage manufacturing, and the source of the core PPI.

The industry index is the finished stage of a product and would most often be sold to a retailer — the grocery story — as we mentioned above.

Why is PPI important?

Any kind of change in producer prices, especially for the industry index mentioned above, will be a leading indicator if consumers will pay more or less and whether inflation — the higher costs of goods — is a worry or not. Higher producer prices mean consumers will pay more when they buy, whereas lower producer prices likely mean consumers will pay less at the retail level. Consumer prices are tracked by the monthly CPI report.

Low inflation is considered good for the economy as it increases consumer spending while boosting corporate profits and stocks

Commodity prices vary from month to month but food and energy, which make up nearly one quarter of PPI statistics, are the major source of volatility in prices when tracking PPI. That's why comparisons over a three- to five-month period are better for gauging changes in PPI numbers. Analysts say the best way to measure to PPI is to look at the same period from the previous year, so the numbers from February 2013 should be compared to February 2012.

How is PPI tracked?

The information is gathered by the Bureau of Labor Statistics, which is part of the Department of Labor. Reports are issued the second week of the month and reflect the previous month's figures. So a report released in October is data from September.

Here's a sample of a PPI report from January 2012: "The Producer Price Index for finished goods declined 0.2 percent in December. Prices for finished goods fell 0.8 percent in November and 0.2 percent in October. Prices for finished goods less foods and energy advanced 0.1 percent in December."

Like so many other government reports, PPI data are often revised over time, usually within three months of an initial release.