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Session 2.2. Elements of Price Analysis

Session 2.2. Elements of Price Analysis. PAT. Learning Objectives. By the end of this session, participants should be able to: Explain use of CPI & its potential to underestimate extent of real food price increases

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Session 2.2. Elements of Price Analysis

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  1. Session 2.2.Elements of Price Analysis PAT Price Analysis Training

  2. Learning Objectives By the end of this session, participants should be able to: • Explain use of CPI & its potential to underestimate extent of real food price increases • Explain the implications of using nominal vs. real prices for analyzing household food security • Analyze graph of nominal & real food prices & identify implications for HH food security of any changes • Calculate real prices of particular good in the country based nominal prices and the CPI Price Analysis Training

  3. Reminder: Why prices are important to WFP • Prices provide key to understanding market behavior • Costs & price differences along marketing chain - from farmer to consumer - indicate where markets may be weak, failing or functioning well • Market performance: analyzed mainly through price analysis Price Analysis Training

  4. What is reality? But… …to understand market reality, it is important to be understand what a real price is. Price Analysis Training

  5. Nominal vs. Real Prices Nominal price: • denotes current monetary value of good/service (as observed by monitor in shop, at market stall) • Changes determined by: • Inflation • Seasonality • Cycles • Production trends • Stochastic factors Real price (PR): • Nominal price (PN) adjusted by a price index of a basket of other products (I) • PR = (PN/I) • Important to use real prices when inflation is high (i.e. high spread between nominal & real prices) Price Analysis Training

  6. Aspects of Market Price AnalysisThe Consumer Price Index (CPI)… • Measures level of prices facing consumers. (Increase in overall level of prices is inflation) • Expresses cost of market basket of goods relative to its cost in a base period. • Based on budget of typical urban family (in most countries) Price Analysis Training

  7. Constructing the CPI Basket of goods: • Typical basket of goods commonly purchased by HHs (e.g., grain, flour, other food items, drinks, fuel and energy, clothing, household goods, school fees etc… Base year: • CPI is price of basket of goods & services relative to price of same basket in some base year Food vs. non-food inflation: • Weights determine which good is driving general inflation Price Analysis Training

  8. Aspects of Market Price AnalysisThe Consumer Price Index (CPI)… CPI2009 CPI in base year = Cost of market basket2009 Cost of market basket in base year When constructing such index numbers, it is conventional to set the index at 100 in the base period. Thus: CPI2009 100 = Cost of market basket2009 Cost of market basket in base year Resulting in: X 100 CPI2009 = Cost of market basket2009 Cost of market basket in base year Price Analysis Training

  9. Aspects of Market Price AnalysisUnderstanding the CPI… • Suppose: 2009 CPI is equivalent to “143.5” • Simply means: In 2009 it costs 143.5 currency units (francs, dollars, dinars, etc.) to purchase the same market basket of goods & services that cost 100 currency units in the base year Price Analysis Training

  10. Quick Quiz Answer: 6300 2100 X 100 = 300 • A WFP monitor finds the cost of a market basket in December 2009 costs 6300 francs. • In 2000, the base year, the cost of the same basket was 2100 francs. • What is the CPI in December 2009? X 100 CPI2009 = Cost of market basket2009 Cost of market basket in base year Price Analysis Training

  11. Aspects of Market Price AnalysisUnderstanding the CPI… In absence of inflation: • Value of money stays constant over time. Therefore, it is easier to compare prices over time In presence of inflation: • Prices need to be adjusted for inflation to enable comparison in constant money terms over time – to determine whether consumers are better off – or not Price Analysis Training

  12. Limitations of the CPI to be aware of… The CPI is… • not easy to calculate • available only as secondary data. • usually not available regularly (e.g., on a monthly basis) or at geographical level • CPI does not take into account all items in the economy. If available it is better to use the GDP deflator Price Analysis Training

  13. Limitations: Nominal prices • Where high inflation disconnects price from real economy, economic agents do not consider nominal price as a relevant indicator for decision making • Nominal price can be manipulated by government or private actors (price control, speculation…) Price Analysis Training

  14. Aspects of Market Price AnalysisTurning nominal into real prices • Formula translates non-comparable monetary figures into directly comparable real figures. • Same concept is used to analyze wages, to determine by how much purchasing power has been eroded by inflation (a reason to prefer real prices in market analysis) Preal in 2009 X 100 Pnominal in 2009 CPI2009 = Price Analysis Training

  15. Limitations: Real prices • Bias due to the use of inappropriate CPI to compute real price: use of annual CPI for monthly data or use of CPI from one region to compute real price in another region (ex: urban CPI for rural areas…). • If food item contribution to CPI is high, it induces downward bias in food real price – i.e., it underestimates extent of real price increase. It is better to use a non food CPI Price Analysis Training

  16. Quick Quiz Answer: 1200 300 X 100 = 400 • In December 2009, the WFP monitor visits the market and finds that the cost of one kg of maize at the market is 1200 francs • What is the real price of maize (using same December 2009 CPI of 300)? Preal in 2009 X 100 Pnominal in 2009 CPI2009 = Price Analysis Training

  17. Nominal vs. Real PricesWhich deflator to use? • Choice of deflator – of an index – is important: its construction depends on data availability for the index • CPI is not a good deflator if the concerned product accounts for a high % of index (then the real price will minimize the degree of relative price changes) • Using CPI requires a good knowledge of the composition of the basket • Using urban-based CPI to deflate a rural-based nominal price is not appropriate (due to different basket compositions and weights) Price Analysis Training

  18. Nominal vs. Real PricesWhich deflator to use? • If real price changes aim to inform production (not consumption) incentives, a better index is GDP deflator • Concerns: • CPI is not always appropriate • GDP deflator is rarely available on a monthly basis • Seasonal price indices should be constructed (more on this tomorrow…) Price Analysis Training

  19. Implications for Food Security? Changes in maize nominal and real prices over time in Rwanda What are the implications of the graph for HH food security? Price Analysis Training

  20. Real and nominal maize price comparison 2004 2005 2006 2007 2008 2009 What are the implications of the graph for HH food security? Price Analysis Training

  21. x = z Wages & “Real” Wages Quick quiz: Purchasing Power in Marketastan Dec 09 CPI: 300 Jan 09 CPI: 150 Dec 09 wage: 8 marks Jan 09 wage: 5 marks Are people really better off now compared with a year ago? To determine if people are really better off this year compared with last (in terms of purchasing power): • Calculate  in CPI over the year • Calculate  in nominal wage over the year • Compare: Is 2 > 1? If yes, people are better off • Answer: • 1.  in CPI: (300 – 150) = 1.00 150 • 2.  in Wages: (8 – 5) = .60 5 • Compare: .60 < 1.00 • i.e. real wages rose less than real prices • People are worse off 1. end-year CPI – begin-year CPI begin-year CPI 2. end-year wage – begin-year wage begin-year wage Price Analysis Training

  22. Small Group Work Please turn to Workbook Exercise 2.2.a. The Marketastan File: Wheat Price Trends in Marketastan (use Excel data file: 4.1. Wheat IPP for Marketastan.xls) Price Analysis Training

  23. Marketastan 2.2.a. Debriefing Part I: Do you agree with southern politicians, that wheat prices are same in Northville as in other areas of Marketastan? That conditions in Central Province are better than in the south? Why? Part II: Were people in Marketastan worse off by end- 2009 compared with 2008? 2007? Price Analysis Training

  24. Wrap-up: Interpretation and Decision-Making Interpretation • Price analysis informs supply: deficit/surplus status, seasonality of production, inflows and outflows of food • Complementary information needs: • Relative prices: in terms of livelihoods and geography • Inflation • HH income sources • Wage rates • Levels of income • Availability - food aid distributions • Market functioning • Contribution to decision-making: • Help determine potential/actual impacts of aid distributions • Help in formulation of early warnings • NOTE: Not stand-alone indicator: context is very important Price Analysis Training

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