Ubiquitous Price Index– There is a Price Index for Every Thing: Understand there– Real Meaning, Use, Importance…

Price indexes have been around for centuries, and are commonly used in everyday activities in business, government. However, the complexities of a price index is not always fully understood… The basic concept of the price index is to facilitate comparison of two sets of prices of just about anything and they can be formed, either over time (temporal index) or regions (spatial index) for just one common item, or group (e.g., market basket) of items…

The index model is used in all areas of life, from the stock market (most famous of which is probably the Dow Jones Industrial Index), to inflation… Indexes are used for wage levels, corporate profits as a percentage of GDP, and almost anything that can be measured… It’s used to compare where the price levels are now, to where it’s been in past… A small sample of popular price indexes (there are hundreds of them) are as follows:

  • Consumer Price Index (CPI): Measures the change in prices for goods and services that consumers pay in their daily lives…
  • Producer Price Index (PPI): Measures the change in prices that manufacturers and producers experience on materials necessary for conducting business…
  • Employment Cost Index (ECI): Measures the change in the cost of hiring employees in various fields…
  • Gross Domestic Product (GDP): Measures the change in the level of prices of all new, domestically produced, final goods and services in an economy…
  • Higher Education Price Index (HEPI): Track the change of the main cost drivers in higher education…
  • Wholesale Price Index (WPI): Represents the price of goods at a wholesale stage i.e. goods sold in bulk and traded between organizations instead of consumers…
  • Food Price Index (FFPI): Monitors the change in costs in the global agricultural commodity markets…
  • House Price Index (HPI): Broad measure of changes and movement of single-family house prices…
  • Medical Care Price Indexes (MCPI):  Measure changes in the cost and quantity of medical care services…
  • Big Mac Price Index (BMPI): Tracks change in price of McDonald Big Mac hamburgers in countries worldwide… it’s regarded as an indicator for the purchasing power of an economy…

Consumer Price Index (CPI): CPI is a measure of the inflation and it’s calculated monthly by the Bureau of Labor Statistics (BLS)… and it’s considered the standard measure by which inflation is tracked… The CPI is one of broadest interpretations of inflation and it represents most consumer purchases of goods and services. Also at wholesale level, the ‘producer price index’ (PPI) is used to track inflation. For the CPI, the BLS classifies the cost of both goods and services into more than 200 categories, arranged into eight major groups, as shown in the chart:

The CPI affects everyone’s life in many ways, e.g.; Federal Reserve sets its interest rate policy based on the core CPI rate. Thus, all interest rates: mortgage rates, bank savings rates, credit card rates… are all related to the CPI If you get wage increase based on a change in ‘cost of living’, then CPI is usually the rate that sets the standard… Social Security payment increases are all based on the core CPI…

The CPI impacts most– business, workers, recipients of government subsidies… hence there are many important reasons to understand it… Here is a common formulation to calculate the Consumer Price Index (CPI):

According to Investopedia; CPI is one of the most highly viewed economic indicators, and its calculations impact both equities and fixed-income markets… as well as, Federal Reserve monetary policy… Also it goes far in shaping public opinion about state of the economy, and analysts use it to generate predictions about economic trends and where the economy might be heading…

But there are concerns that the CPI is misapplied and transformed from measuring the ‘costs of goods’ (its intended use), to measuring the ‘cost of living’… And since CPI is limited in capability to examine all costs in its calculation for ‘cost of living’, some economists suggest that CPI is a misleading indicator when used for ‘cost of living’… However, this debate will not be resolve here…

And for now let’s consider the holiday season, and the use of two price indexes:

Christmas Price Index®: PNC Financial Services Group prepares a price index each year as a whimsical way of tracking inflation and uses a calculation  method that is similar to government’s consumer price index (CPI)… But as the name implies, it measures the ‘cost of buying’ the gifts given in the song; Twelve Days of Christmas, and these include; 12 Drummers Drumming; 11 Pipers Piping; 10 Lords Leaping; 9 Ladies Dancing; 8 Maids Milking; 7 Swans Swimming; 6 Geese Laying; 5 Golden Rings; 4 Calling Birds; 3 French Hens; 2 Turtle Doves; 1 Partridge in Pear Tree…

This year, of the 12 items measured by the Christmas Price Index, eight remained the same price as last year. Wage inflation boosted the cost of ‘pipers piping’ and ‘drummers drumming’… The real increase this year, however, was the cost of ‘two turtle doves’, which increased a whopping 29% this year due to a shortage.

‘Turtle doves’ only lay eggs a few times a year, two eggs at a time, making them more difficult to come by than a ‘hatchimal’ this time of year. On the other side of the spectrum, the cost of a ‘partridge’ fell 20% – I guess there are loads of partridges to be had this year. The cost of a ‘pear tree’, like the cost of ‘five gold rings’, remained the same.

With those adjustments in mind, if you add up the cost of all the gifts in 12 Days of Christmas song this year, it would cost $34,363.49. If, however, you really want to impress your true love by nabbing all 364 items – the number of the items as repeated throughout the song over and over (and over) – you have to cough up $156,507.88, nearly $1,100 more than last year…

Christmas Travel Index: By tracking 11,000 airfares for flights during holiday season every single day, the price index calculates average fare for most popular markets.. According to Hopper; best time to purchase flights for Christmas is about 80 days before the holiday… According to other studies; the sweet spot is 2 months out (57 days, to be exact)…

But beyond question of when to buy tickets, the best holiday fares typically include; ‘usual suspects’ — checking alternate airports, finding connecting fares lower than non-stops, looking for lower fares at inconvenient hours… According to George Hobica; best tip for buying airline tickets is– when you find a good deal, buy it…

Price indexes are not just for study by academics, business people, and government officials… out of idle curiosity. Rather, these indexes have an important impact on policymakers’ decisions and on the operation of the economy… Employers often look to these indexes in determining wage and contract adjustments based on a specific price index…

Some government programs, e.g.; social security payment benefits… based on price indexes… Private business contracts may provide for price adjustments based on indexes… payments, e.g.; child support and rent have been tied to price indexes… Hence, take the time to understand them (pros & cons), learn from them, but be cautious when using them…