Measuring the substitution effect in Producer Price Index goods data: 2002–16

This article examines the substitution effect in Producer Price Index (PPI) data for final- and intermediate-demand goods. The analysis demonstrates that PPIs calculated with Fisher and Tornqvist formulas, which allow for substitution, are generally lower than PPIs calculated with a Laspeyres formula. This result implies that the effect of substitution toward relatively less expensive goods dominates the effect of substitution toward relatively more expensive goods. The Producer Price Index (PPI) measures the average change in prices received by domestic producers for their marketed output. The principal PPIs used for analyzing high-level inflation, and the focus of this article, are the Final Demand–Intermediate Demand (FD–ID) price indexes. Final-demand PPIs measure price change for outputs sold for personal consumption, as capital investment, to government, and as exports. Intermediate-demand PPIs measure price change for outputs sold to businesses as inputs to production, excluding capital investment.1 PPIs are calculated with a modified Laspeyres formula.