The HSBC Purchasing Manager Index (PMI) measures the factory production based on the monthly responses of purchasing executives in around 500 manufacturing companies. A value over 50 means expansion and a value under 50 means contraction.
Now, should we use the WPI or the GDP deflator?
The GDP deflator measures the prices of all goods produced, whereas the WPI measures only the prices of goods/services bought by consumers. In particular, an increase in the price of goods bought by firms/government shows up in the former but not the latter. Also, imported goods are not part of the GDP and do not show up in the GDP deflator. Lastly, the WPI assigns fixed weights to the prices of different goods whereas the GDP deflator assigns changing weights (a fixed basket of goods v. a changing basket of goods).
We use two indices in general, the Laspeyres index (which works with a fixed basket of goods) and the Paasche index (which works with a changing basket of goods).
The Laspeyres price index is equal to
and the Paasche price index is equal to
\[P = \frac{\sum p_t q_t}{\sum p_0 q_t} \times 100,\]where \(P\) is the price index, \(p_t\) is the current price, \(q_t\) is the quantity used in the current period, \(p_0\) is the price of the base period, and \(q_0\) is the quantity used in the base period.
Laspeyres requires quantity data from only the base period, which allows a more meaningful comparison because changes in the index can be attributed to changes in price, but may overweight goods whose prices increase and does not reflect changes in buying patterns over time.
Paasche reflects current buying habits because it uses current quantities, but it requires quantity data from the current year, which may be difficult to obtain. It is difficult to attribute changes in the index to price changes alone and tends to overweight goods whose prices have declined. The prices need to be recomputed each year.
Fischer’s ideal index is equal to the geometric mean of these two indices.
When the prices of different goods are changing differently, the Laspeyres index tends to overstate the increase in cost of living. This is because it does not take into account that consumers can replace more expensive items with less expensive items.
Conversely, the Paasche index tends to understate the increase in cost of living. While it takes the substitution effect into account, but does not take into account the decrease in the consumers’ welfare resulting from this substitution (because we take a fixed basket of goods). This issue is known as substitution bias.
As new goods are introduced, consumers have more choice so the dollar is worth more.
Some quality change may be unmeasured. If the quality of a good deteriorates while its price remains the same, the value of a dollar is dropping.
Therefore, it is difficult to compare WPI (Laspeyres) and the GDP deflator (Paasche), since they are both bad in their own ways. They follow similar trends.
We can compare today’s prices with that of a different year’s as
\[\text{Amount in today's dollars} = \text{Amount in other year's dollars} \times \frac{\text{Price level today}}{\text{Price level in other year}}.\]When we perform the above correction, we are said to index the amount for inflation. Approximately, when we put our money in a bank, the real interest rate is equal to the nominal interest rate minus the inflation rate.
Unemployment rate is the statistic that measures the percentage of people who want to work but do not have jobs, reflecting the performance of the economy.
Labor force is the sum of the employed and unemployed, and the unemployment rate is the percentage of the labor force that is unemployed. The labor force participation rate is the percentage of the adult population that is in the labor force.
The average rate of unemployment around which the economy fluctuates is called the natural rate of unemployment. It is the rate of unemployment towards which the economy gravitates. It should be noted that natural does not mean desirable.