Producer Price Index - PPI

You know inflation, right? Pump air into a football, it gets bigger. Keep eating Boston Cream pies, you’ll get bigger. Those are a couple kinds of inflation.

In economics, inflation has to do with prices. When prices get bigger, that’s inflation. A couple of years ago, a movie ticket cost $10. Now it costs $12.50. Inflation.

Inflation refers to the amount that prices rise over a given period of time. It's a key driver of the PPI. But PPI measures inflation in a specific part of the economy. It's relatively easy to see how much prices are increasing when you're talking about a single product.

You go to the store to pick up some adult diapers so you can stream Black Mirror without any interruptions. This week, a pack costs $12.50. Last month, when you were making your way through Season 5 of Breaking Bad, a pack cost $12.35. Two months from now, when you're heavy into Orange is the New Black, you head back to the store. A pack of adult diapers is now at $12.60.

So...from $12.35 to $12.50 to $12.60. Prices are going up for adult diapers. The A.D.I.I., The Adult Diapers Inflation Index, is climbing fast. In just over 2 months, they went up about 2%, an annualized inflation rate of around 12%.

Following one product’s inflationary tales should be pretty easy. But when you try to discern inflation rates across an entire economy, things get more complicated. In a dynamic, large, complex economy, prices on different products move different directions at different times. Adult diapers might see rising prices. But at the same time, prices for hemorrhoid cream might be dropping.

Meanwhile, prices for stool softeners are holding steady. Different items. Different inflation trends. Because different parts of the economy can have different price trends, there are different economic stats to track separate segments of the economy.

The producer price index is one of these. The PPI measures a particular kind of inflation. Specifically, it tracks changes in prices for wholesale goods. Hence the catchy titling there with the word “Producer”…and no, it’s not just about the cost of making the next Spider-Man.

The PPI is not about the prices consumers pay at the store. Rather, the PPI follows prices that companies pay to get the raw materials they use to make the stuff that shows up in the aisles at Walmart, or at Amazon's warehouses. The PPI contrasts with the CPI, or consumer price index, which measures the retail prices the regular consumer pays.

You make authentic racoon skin caps to sell to War of 1812 reenactors. You retail the caps for $100 each. Last month, you paid an average of $10 for a racoon pelt. The $100 retail price represents the consumer price for the cap. Meanwhile, the $10 for the pelt represents one of the producer prices you pay. You also have to pay for string and pelt wax and whale oil to run your authentic 1812-era manufacturing facility.

But to keep it simple, we’ll just look at pelt prices as a stand-in for PPI here. This month, the price for the raccoon pelts goes up to an average of $11 each. That's 10% higher from last month. So, the raccoon pelt component of your personal PPI was up 10% from last month to this month.

The real-life PPI is made up of a diverse basket of wholesale goods. Energy components, like crude oil. Food stuffs, like the prices for things wheat or rice. And other components from various industries all get averaged together to create a single measure.

The U.S. government releases a monthly report outlining changes in the PPI. An increase of 0.1% or 0.2% is considered normal. Anything above that mark could indicate rising inflation pressure.

But people don't freak out if one month shows a big move. Commodities and wholesale prices tend to fluctuate quite a bit. It only starts to matter if big gains pile up a few months in a row.

Even though it doesn't measure direct consumer prices, the PPI represents an important economic measure.

Your coonskin cap business experienced a 10% rise in wholesale prices this month. The price for a racoon pelt rose to $11 from $10. You have a decision. You can pass that cost onto your consumer, increasing your retail price from $100 to $101 to cover the increased expense. Or you can eat the additional cost and live with lower profit margins.

Usually, businesses are reluctant to pass on increased prices. Since commodity markets fluctuate a good deal, this month's cost increase can disappear next month.

Also, retail markets are generally competitive. The first company to raise prices can lose out on market share. If you raise your prices, and your competition doesn’t follow suit, customers are going to flock to the cheaper brand. They get a price advantage because you panicked and raised prices.

So...if you raise your coonskin prices to $101 to cover the rising costs, Furry Tops Inc. might swoop in with a sale and grab up a bunch of your customers. The lost sales would hurt more than the slight dip in profit margins. So you hold steady and hope that the increased producer prices are temporary.

However, a company can't eat increased costs forever. An upward trend in the PPI will eventually find its way to the CPI.

The prices for your raccoon pelts continue to rise. It's $11 this month. Next month, it rises to $11.25. The following month sees it go a tick higher to $11.35. Six months down the road, it’s climbed to $13 a month.

At that point, you can't take it anymore. You have to increase the price for your customers. You raise the price for your coonskin caps to $103 to make up for the $3 price increase you've seen in raccoon pelts over the past several months. But prices for pelts are so high that Furry Tops Inc. can't swoop in with lower prices. They have to increases prices too, because they've been squeezed with the same high pelt prices you have.

Similarly, the general PPI figures eventually feed into higher retail price levels. If they don't, higher PPI figures eat into corporate profits, which can impact stock prices, and eventually the overall economy.

So...yeah. That’s the Producer Price Index. A measure of wholesale inflation. Complex, but still easier to keep track of than all those Boston Cream pies you ate last month.