Wholesale Price Index Meaning
Wholesale price index is an index that tracks the movement of the prices of the frequently traded goods at the wholesale level (before the retail level) in a territory or a jurisdiction.
The definition above may be quite vague in terms of:
- What is a territory and what good are considered?
- Why are wholesale prices considered and not retail?
The territory is an area under the jurisdiction of a state. The wholesale price index (WPI) is usually calculated by a country, so the word territory would mean a country. The goods considered are those which are frequently traded in the local market. Hence this would also depend upon the country that is calculating it. For instance, the USA may want to consider the export of its apples as a good to form part of its basket of goods in the WPI calculation, while countries in the middle east would want to consider dry fruits in its basket. So, this differs from territory to territory.
The reason for considering wholesale price lies in the fact of it being easily accessible than the retail. The data collected from wholesale dealers are also more reliable than the retailers because they can be validated. Most importantly, the cost involved in getting a wholesale price is effective in terms of cost and also efficient in terms of time than the retails price index.
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For eg:
Source: Wholesale Price Index (wallstreetmojo.com)
Wholesale Price Index Calculated
The WPI is calculated as mentioned earlier on the basis of goods. Let us understand the same with an example.
Say in the USA the price of an apple is $5 in 2011-12. In 2016-17 price of an apple is $6. So, the price has changed by $1. In terms of percentage (%) change it is (1$/5$) *100 = 20% over period of 5 years.
The base year is 2011-12 and WPI is always assumed to be 100 for the base year. Hence WPI for 2016-17 would be 100+20 =120.
In this way, all the goods that are considered by the territory are calculated. A weighted average for the same is the WPI for the territory.
Uses and Importance
- As earlier mentioned in the definition, WPI is a measure of inflation. Hence the governments and the Banking regulatory authority can use them for fiscal and monetary policies.
- It helps to forecast the future selling price of a product affected due to inflation; hence the business can estimate the demand for the product at the inflated effected price and make suitable modifications to the production and distribution strategies and plans.
- The foreign exchange rates are affected due to inflation, hence they can be used to measure purchasing power parityPurchasing Power ParityPurchasing power parity formula depicts the variation in the exchange rate between the currencies of two different nations. It is evaluated as the fraction of a particular goods' cost in one country to that in the second country.read more.
Components of Wholesale Price Index (WPI) and its Selection
The primary component would be the goods selected by the territory. It is essential that the goods selected are diverse in terms of the industry, customer preferences, importance of it to the territory. Having it construed to one aspect may not depict the right WPI as it does not represent the population.
Difference Between WPI and Producer Price Index (PPI)
- PPI is considered to be a more robust method than WPI. In PPI components related to services are also considered. The computation of PPI is similar to that of PPI. The PPI is usually used by countries that are more services oriented. USA and UK are the countries majorly using the PPI index.
- PPI components are majorly broken down into 3 segments, they are Industry based, commodity-based and commodity-based final and intermediate demand. This essentially also reduces the double counting in the case of WPI.
Advantages
- Represents the overall growth or decline of an economy based on which the reasons can be sought by conducting micro-level scrutiny.
- The 5-year plan as made by most of the countries are based on the inflation rates calculated using the WPI.
- It helps the business to make budgets affected by the probable inflation.
- Comparing the goods pertaining to different industries helps the government to draft policies for the improvement of underperforming sectors and insight of different Industries to concentrate and build.
- The industries can compare, analyze their performance with the other products and take industry-wide measures to improve and build upon.
Disadvantages
- WPI considers the impact of only a sample of goods that are supposed to represent the entire population of goods. Always an inherent riskAn Inherent RiskInherent Risk is the probability of a defect in the financial statement due to error, omission or misstatement identified during a financial audit. Such a risk arises because of certain factors which are beyond the internal control of the organization.read more of business exists.
- Since it is representative of the population, the inflation calculated as a whole using the weighted averageWeighted AverageThe weighted average formula is simply summing up the products of each value with its respective weightage. Here, more significance is given to the weightage of the values rather than the variables themselves.read more may not be accurate.
- Different countries use different products to calculate the WPI. Therefore, it is not always comparable to other countries.
- It does not serve as the right benchmark for countries dominated by the service sector.
Conclusion
Given that the main aim of the entire exercise is to conclude at an inflation rate that is reliable to the entire territory as a whole, the countries are required to evaluate the best index that suits them. For instance, Wholesale Price Index is used only in a few countries, mostly developing countries that are manufacturing dominant such as India. While the service sector dominant countries use PPI.
Yet another measure known as consumer price indexConsumer Price IndexThe Consumer Price Index (CPI) is a measure of the average price of a basket of regularly used consumer commodities compared to a base year. The CPI for the base year is 100, and this is the benchmark point.read more (CPI) is also used by 150+ countries. Hence all these said and done, it is also essential to determine the frequency in which the decision is required to be made using the indices. For example, WPI and PPI can be calculated weekly as well a monthly basis, but CPI requires more inputs which are in most cases not readily available and hence would be released on a monthly basis. Countries may even tend to use multiple indices and conclude. In the end, what matters in how reliable and reasonable the inflation rate calculated.
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