PAT Session 2.2. Elements of Price Analysis WFP Markets Learning Programme2.2. 1 Price Analysis Training

PATSession 2.2.

Elements of Price Analysis

WFP Markets Learning Programme 2.2. 1Price Analysis Training

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


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


But…

…to understand market reality, it is important to be understand what a real price is.


What is reality?

Nominal vs. Real Prices

Nominal priceNominal price::

denotes current monetary value denotes current monetary value of good/service (as observed by of good/service (as observed by monitor in shop, at market stall)monitor in shop, at market stall)Changes determined by:Changes determined by:

o Inflation Inflation o Seasonality Seasonality o CyclesCycleso Production trendsProduction trendso Stochastic factorsStochastic factors


Real price (PReal price (PRR):):

Nominal price (PNominal price (PNN) )

adjusted by a price index of adjusted by a price index of a basket of other products a basket of other products (I) (I)

PPRR = (P = (PNN/I)/I)

Important to use real prices Important to use real prices when inflation is high (i.e. when inflation is high (i.e. high spread between high spread between nominal & real prices)nominal & real prices)

Aspects of Market Price Analysis

The 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)

WFP Markets Learning Programme Price Analysis Training 2.2.6

Constructing the CPIBasket 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



The Consumer Price Index (CPI)…


CPI 2009

CPI in base year

Cost of market basket 2009

Cost of market basket in base year=

CPI 2009

100Cost of market basket 2009

Cost of market basket in base year=

CPI 2009


Cost of market basket in base year= X 100

When constructing such index numbers, it is conventional to set the index at 100 in the base period. Thus:

Resulting in:

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



Understanding the CPI…

Quick Quiz


CPI 2009


Cost of market basket in base year= X 100

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?

Answer:

63002100

X 100 = 300

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



Understanding the CPI…

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


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…)



Turning 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 2009Pnominal in 2009

CPI 2009= X 100

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


Quick Quiz


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)?

Answer:

1200 300

X 100 = 400

Preal in 2009Pnominal in 2009

CPI 2009= X 100


Which 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)



Which 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…)


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?

Real and nominal maize price comparison

What are the implications of the graph for HH food security?

2004 2005 2006 2007 2008 2009


Wages & “Real” Wages

To determine if people are really better off this year compared with last (in terms of purchasing power):

1.Calculate in CPI over the year

2.Calculate in nominal wage over the year

3.Compare: Is 2 > 1? If yes, people are better off


1. end-year CPI – begin-year CPI

begin-year CPI

2. end-year wage – begin-year wage

2. begin-year wage

Quick quiz: Purchasing Power in Marketastan

Dec 09 CPI: 300Jan 09 CPI: 150

Dec 09 wage: 8 marksJan 09 wage: 5 marks

Are people really better off now compared with a year ago?

Answer: 1. in CPI: (300 – 150) = 1.00

150

2. in Wages: (8 – 5) = .60 5

3.Compare: .60 < 1.00 i.e. real wages rose less than real prices

People are worse off

x = z

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)


Small Group Work

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?


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


Documents

PAT Session 2.2. Elements of Price Analysis WFP Markets Learning Programme2.2. 1 Price Analysis Training