PAT Session 2.2. Elements of Price Analysis WFP Markets Learning Programme Price 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 WFP Markets Learning Programme Price Analysis Training

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 WFP Markets Learning Programme Price Analysis Training

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

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: o Inflation o Seasonality o Cycles o Production trends o Stochastic factors WFP Markets Learning Programme Price Analysis Training Real price (P R ):  Nominal price (P N ) adjusted by a price index of a basket of other products (I) P R = (P N /I)  Important to use real prices when inflation is high (i.e. high spread between 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 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 WFP Markets Learning Programme Price Analysis Training

Aspects of Market Price Analysis The Consumer Price Index (CPI)… WFP Markets Learning Programme Price Analysis Training CPI 2009 CPI in base year Cost of market basket 2009 Cost of market basket in base year = CPI Cost of market basket 2009 Cost of market basket in base year = CPI 2009 Cost of market basket 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 currency units (francs, dollars, dinars, etc.) to purchase the same market basket of goods & services that cost 100 currency units in the base year WFP Markets Learning Programme Price Analysis Training Aspects of Market Price Analysis Understanding the CPI…

Quick Quiz WFP Markets Learning Programme Price Analysis Training CPI 2009 Cost of market basket 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: 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 WFP Markets Learning Programme Price Analysis Training Aspects of Market Price Analysis 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 WFP Markets Learning Programme Price Analysis Training

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…) WFP Markets Learning Programme Price Analysis Training

Aspects of Market Price Analysis 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) WFP Markets Learning Programme Price Analysis Training P real in 2009 P nominal 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 WFP Markets Learning Programme Price Analysis Training

Quick Quiz WFP Markets Learning Programme Price Analysis Training  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: X 100 = 400 P real in 2009 P nominal in 2009 CPI 2009 = X 100

Nominal vs. Real Prices 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) WFP Markets Learning Programme Price Analysis Training

Nominal vs. Real Prices 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…) WFP Markets Learning Programme Price Analysis Training

Implications for Food Security? Changes in maize nominal and real prices over time in Rwanda WFP Markets Learning Programme Price Analysis Training 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? WFP Markets Learning Programme Price Analysis Training

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 WFP Markets Learning Programme Price Analysis Training 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: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? Answer: 1.  in CPI: (300 – 150) =  in Wages: (8 – 5) = 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) WFP Markets Learning Programme Price Analysis Training 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 compared with 2008? 2007? WFP Markets Learning Programme Price Analysis Training

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 WFP Markets Learning Programme Price Analysis Training