Focus on Economic Data: Consumer Price Index and Inflation, March, 2013

EDUCATOR'S VERSION

This lesson printed from:
http://www.econedlink.org/e1161

Posted May 10, 2013

Standards: 8, 10, 18, 19

Grades: 9-12

Author: Douglas Haskell

Posted: May 10, 2013

Updated: October 27, 2014

DESCRIPTION

This lesson focuses on the Consumer Price Index (CPI) and rate of inflation reported April 16, 2013, by the U.S. Bureau of Labor Statistics (BLS) for the month of March, 2013. Students read the BLS report, analyze the meaning of the CPI data, determine the change in consumer prices, and explore the impact of the change in the price level on themselves, their families, consumers, and producers.

KEY CONCEPTS

Board of Governors, Business Cycles, Consumer Price Index (CPI), Cost-Push Inflation, Demand-Pull Inflation, Inflation, Inflation Risk, Interest Rate, Macroeconomic Indicators, Macroeconomics, Price, Price Level, Price Stability, Real Interest Rates, Real vs. Nominal

STUDENTS WILL

  • Identify the current level, rate of change, and recent changes in the consumer price index.
  • Identify the factors that have influenced recent changes in the rate of inflation.
  • Identify the potential policy implications of the current economic conditions, including deflation.
  • Describe how inflation and deflation impact individuals, families, and different groups in the economy.

Current Key Economic Indicators

as of November 10, 2014

Inflation

The Consumer Price Index for All Urban Consumers increased 0.1 percent in October on a seasonally adjusted basis. The core inflation rate increased the same amount. For the previous 12 months, the index increased 1.7%, the same rate as reported in the September report.

Employment and Unemployment

According to the October report of the Bureau of Labor Statistics, the unemployment rate fell from 5.9% to 5.8%, and the number of individuals unemployed also decreased. Total nonfarm employment rose by 214,000 in October. Employment gains were concentrated in retail trade, food services and health care.

Real GDP

The advance estimate for real GDP growth in the third quarter of 2014 was 3.5%, a decrease from the revised second quarter growth of 4.6%. Inventory investment reduced third quarter growth, while it added to second quarter growth. In addition, consumer spending increased at a lower rate in the third quarter, compared to the second. Finally, business investment increased in the third quarter, but at a lower rate than in the second quarter.

Federal Reserve

The FOMC believes that the labor market has shown considerable improvement and the risks of inflation rising above its 2% target are low. Therefore, the Federal Reserve announced plans to end its purchase of financial assets. In addition, the federal funds rate will remain at its current low level. However, the FOMC has signaled its willingness to increase the federal funds rate if inflation shows signs of rising above the 2% target.


INTRODUCTION

Each month, the U.S. Bureau of Labor Statistics (BLS) releases an estimate of the level of the consumer price index (CPI) and the rate of inflation in the United States for the previous month. The report provides the most recent current and seasonally adjusted consumer price indexes for all urban consumers, urban wager earners, and the chained index, plus a breakdown by major expenditure groups. The BLS also collects price level data for major metropolitan areas and regions.

This lesson focuses on the April 16, 2013, BLS press release of data on the consumer price index for the month of March, 2013.

[Note to teacher: You can subscribe to receive monthly BLS email news releases. To subscribe, go to the BLS News Service Subscription Page .]


[Note to teacher: For the latest updates on U.S. economic indicators, go to:

[Note on the CPI and Inflation "Focus on Economic Data" LessonsDuring the second semester of this school year (January-May, 2013), EconEdLink will publish five lessons on "Consumer Price Index and Inflation." During this time period, the Focus on Economic Data will begin with the "basics" in January and progressively focus on more complex data, issues, and comparisons. All monthly lessons will include the current data and significant recent changes.

  • December, 2013 (Reported January  16, 2013): CPI and inflation (deflation) basics: What is the CPI? What is inflation and deflation? How are they measured? What do they mean?
  • January, 2013 (Reported February 21, 2013): More details and issues about the measurements and meaning of the measurements of the price level, adding additional concepts.
  • February, 2013 (Reported March 15, 2013): U.S. regional and global price level and inflation comparisons.
  •  March, 2013 (Reported April 16, 2013): The relationships of CPI and inflation data to other economic data, such as GDP, employment. etc. and the business cycle. End of year price level summary and potential issues. THIS LESSON
  • April, 2013 (Reported May 16, 2013):  Year-end review.]

Key Economic Indicators

as of April 16, 2013

Inflation

On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers decreased 0.2 percent in March after increasing 0.7 percent in February. The index for all items less food and energy rose 0.1 percent in March after rising 0.2 percent in February.

Employment and Unemployment

Nonfarm payroll employment edged up in March (+88,000), and the unemployment rate was little changed at 7.6 percent. Employment grew in professional and business services and in health care but declined in retail trade.

Real GDP

Corporate Profits, 4th quarter and annual 2012 Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 0.4 percent in the fourth quarter of 2012 (that is, from the third quarter to the fourth quarter), according to the "third" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 3.1 percent.

Federal Reserve

Information received since the Federal Open Market Committee met in January suggests a return to moderate economic growth following a pause late last year. To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.

PROCESS

We see prices everyday of our lives. We see big prices like $25,000 for a new car and we see small prices like 89 cents for a hamburger.  When the new model of the car goes up to $26,000 we may not realize it, but when the hamburger goes up from 89 cents to 99 cents we do.  When we get used to paying a particular price for something, it disturbs us when the price changes, but we can often find a substitute.  If we purchase a particular item regularly, we may be more aware when the price changes.

[Note to Teachers: Ask your students how they learn the prices of the goods and services they purchase?  Do they comparison shop for lower prices?  Have the prices of goods and services they purchase gone up or down recently?]

Take gasoline, for example.  Gasoline is, maybe, the one product where we can see the price every day. Gasoline prices are posted on big signs for all to see at the gas stations on the corners.  Some people look for the lowest price and select a brand.  Others may be loyal to a brand and choose to pay a little more for their brand.  Unlike gasoline, most prices take a little more work to find.  We have to go into the store and look for them.  We may have to shop around at several stores to find a lower price for something we want.  For everyday purchasing decisions, product prices are good information that helps us make choices.

Prices help us use our income to make decisions about the things we want - what to buy and what not to buy.  When all prices (or most) increase and we experience the effects of inflation (an increase in the average price level in the economy over some time period) we face other decisions. We may have to make difficult choices, giving up some things to have others.  Inflation - a rising price level - erodes the purchasing power of our incomes and threatens our lifestyles.  A falling price level over time - called deflation - sounds great to consumers, but may also have a harmful impact on the economy.

Is inflation or deflation an issue today?  Are prices increasing?  Are they falling? Let's see what the Bureau of Labor Statistics has to say about consumer prices in March, 2013.

[Note to Teachers: Ask your students if they have personally noticed any inflation or deflation?  How have lower or higher gasoline price affected their spending or driving habits?]

Note:  Unless otherwise cited, the quoted materials in this lesson are from the  Bureau of Labor Statistics Economic News Release, "Consumer Price Index Summary," April 16, 2013. URL: www.bls.gov/news.release/archives/cpi_04162013.htm

U.S. Bureau of Labor Statistics Announcement
Consumer Price Index Summary, March 2012
Released April 13, 2012

"The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.2 percent in March on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.5 percent before seasonal adjustment."

The overall price level (CPI-U) went down in March.  Was it "deflation"?   Be careful!  One month does not make a trend and a one month decrease in the CPI-U does not mean deflation.  This is especially true when the overall price level was affected so much by one product group.

The gasoline price index decline 4.4 percent in March. The indexes for electricity and fuel oil also fell.  The larger energy index declined 2.6 percent in March.  March was  a good example of the impact that one product category with more volatile prices can impact the reported "inflation" numbers in the short term.

While the "all items price index (including energy and food) fell in March, the "core" index (excluding energy and food) increased.  The BLS added, "The index for all items less food and energy increased 0.1 percent in March, after a 0.2 percent increase in February. The indexes for shelter, used cars and trucks, medical care, personal care, and airline fares all rose in March."

A "wildcard" like energy and food - products that tend to fluctuate more widely in price - will affect people differently, based on their consumption habits.  Did those who complained about the rise in gasoline prices in February notice as much when gas prices dropped 4.4 percent in March?

When the BLS  reports on prices, it provides two basic numbers.  One is the CPI-U, including a broad variety of goods and services.  This measure of the price level is often referred to as the "headline" number.

The second number is referred to as the "core" rate of inflation and excludes energy and food prices that tend to fluctuate more.  Excluding food and energy is assumed to provide a better picture of the general price level over time.  The BLS uses the term "all items less food and energy."

[Note to Teachers: This is a good time to clarify the difference between the reported CPI-U and the "core" rate of inflation.  Ask your students which one is more meaningful to them?]

Figure 1, below, breaks down the changes in the CPI-U for February and March, 2013 and for the last twelve months by major spending category.  Note the categories with significant changes.

Figure 1

[Teacher Note: This is an opportunity to have students look at the price level changes for different product groups and suggest why those prices have changed more or less than the average?  Have political, economic or natural events impacted some prices more than others?

Use this BLS search page to select CPI data for specific spending categories. data.bls.gov/cgi-bin/surveymost?cu

Selected Consumer Price Index Data for March 2013

Food

"The food index was unchanged in March as a 0.2 percent increase in the index for food away from home offset a 0.1 percent decline in the food at home index. Within food at home, three of the six major grocery store food group indexes declined."

U.S. food prices have been increasing gradually, but not much in March. We are not experiencing the much greater increases in food prices as some other regions of the world.

Energy

"The energy index turned down in March, falling 2.6 percent after a sharp February increase. The gasoline index, which rose 9.1 percent in February, fell 4.4 percent in March."

Energy prices go up and down fairly regularly, depending on a variety of factors - the weather, geo-political issues, trade agreements (or lack thereof), etc.  What will happen next month? Who knows?

 All Items Less Food and Energy

"The index for all items less food and energy increased 0.1 percent in March following increases of 0.3 percent in January and 0.2 percent in February."

Take another look at the changes from February to March in Figure 1, above.   Note the spending category indexes that increased in March.  Compare those changes to energy and food.  How important are energy and food prices in your family's budget?  Did the items you typically purchase go up or down?

Looking at prices over the last year may be more meaningful.  "The index for all items less food and energy increased 1.9 percent for the 12 months ending March. Component indexes rising more quickly than this include airline fare (3.8 percent), medical care (3.1 percent), and shelter (2.2 percent)." 

For the past year, the price index for all items less food and energy increased 1.9 percent.  This is right at the 1.9 percent average over the last 10 years.  Again, look the last column in Figure 1.  What categories increased and decreased?  Did you experience more or less inflation than the average? 

Not Seasonally Adjusted CPI Measures - The Actual Numbers

"The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.5 percent over the last 12 months to an index level of 232.773 (1982-84=100). For the month, the index increased 0.3 percent prior to seasonal adjustment.

In March, 2013, the CPI-U "market basket" cost $232.77.  In 1983, the same "market basket" cost $100.  A year ago, the same basket of goods and services cost $229.39.   Most of the difference over the past year has been higher energy costs.  Again, the big variable is how you spent your income over this time period.  The CPI is a "weighted" index, meaning that each category of spending has a difference level of importance (weight) in the market basket.  You might, for example, spend a larger portion of your income on clothing.  If so, your "personal" price index probably did not increase as much in March as that of someone who spent a larger portion of their income on gasoline.

[Note to Teachers: The BLS "market basket" is a group of goods and services typically purchased by urban families.  It may not reflect the consumption pattern of your students.  Ask the students what they would put in their "market basket."]

The Weighted Index

Figure 2, below, shows the weights of the major categories of items making up the CPI-U.  Note how some categories (energy and other*) have changed greatly in price level since the base period of 1982-84.  Other categories (apparel and recreation) have changed very little in their price level.  The CPI-U for all items has increased from the base period when it was 100 by over 123 percent.

Figure 2

* The "other" category includes items such as tobacco products, personal care products and services, and other personal services.

[NOTE:  Do your students think these categories make sense?  What products do they suggest should be part of the CPI "market basket"? For information about the make-up of the BLS market basket, go to "How is the CPI market basket determined?" in the BLS FAQs .]

Recent CPI-U History

Figure 3, below, shows the monthly changes in the CPI from 2002 through March 2013.  Note the periods of slow price level growth and a few periods of more rapid price level growth.  Also note the few months of decreases in the CPI-U, the most recent of which were in late 2008 - the beginning of the recession.  At that time, many analysts feared a period of deflation - an extended period of price level decrease.  Continued price level decrease may have signaled a longer continuation of the recession.

Figure 3

Connections between the CPI and Other Macroeconomic Data

It is sometimes instructive to find relationships between various macroeconomic data.  These relationships may sometimes give us a more broad picture of the economy. For instance, there is a general relationship between output (GDP) and employment. As GDP increases, employment tends to increase.  In the past several months, as real GDP has increased, the unemployment rate has decreased. One piece of data may confirm the meaning of the other.

Figure 4, below, provides four sets of macroeconomic data - CPI, unemployment, real GDP growth and the federal funds rate target. Notice the long term relationship of periods of output growth and decline with the changes in the unemployment rate. This relationship makes sense as the number of employed is directly related to output. Some increase in output can be attributed to improvements in productivity, but growth is very much dependent on labor force growth and employment. In late 2008 and 2009, as U.S. real GDP declined, the unemployment rate increased substantially.  Note the "recovery" from 2010 to today.

Figure 4

Business Cycles

Business cycles or periodic fluctuations in growth and employment illustrate the relationships of some data (see Figure 4). When the National Bureau of Economic Research (NBER) tracks cycles in order to identify recessions, they use the combination of employment, GDP growth and other factors. How do consumer prices fit into this analysis? The NBER uses real GDP growth and real personal income as primary factors identifying business cycles. Using employment and income data adjusted for inflation allows the NBER to make more accurate comparisons from one data period to the next.

[Teacher Note: This is a good opportunity to use the business cycle to illustrate the growth pattern of the U.S. economy over the past couple of years - expansion, peak, contraction, and trough.  Are we still in the trough?]

Inflation and GDP

Accurate measurement of gross domestic product or GDP growth is also dependent on the accurate measurement of inflation. A rise in the price level "inflates" the measurement of GDP growth - miscalculating real growth in the economy. A more meaningful measurement of the growth of output is real GDP - the nominal GDP measurement adjusted for the impact of inflation.  Although CPI is the most common measurement of inflation for many uses, the adjustment of GDP uses a process based on the GDP deflator. Both the CPI and the GDP deflator are measurements of average prices, but the GDP deflator includes all of the goods and services produced in the economy, not just the CPI market basket.

The GDP is the market value of all goods and services produced in a year. Real GDP is the market value of those goods at a constant price level.  Measuring the nation's output in a year at a constant price level means that you can accurately compare it to the output in another year.

CPI vs. GDP Deflator as Measures of Inflation

The rate of inflation rate determined by the CPI and GDP deflator are normally quite similar.  Since the CPI uses a fixed market basked of goods and services, it assumes a fairly constant pattern of consumer purchases. Over time, the market basket may be changed, based on changes in consumer behavior. The GDP deflator uses a flexible basket of goods and services based on the actual quantities of goods and services produced in a year, while the prices of the goods and services are fixed. The GDP deflator uses a much larger quantity of goods and services.

The CPI does not take into account substitution - the tendency of consumers to choose lower priced goods in place of more expensive ones. Just the opposite sometimes happens, as consumers may choose to purchase more expensive goods as their incomes increase. The GDP deflator can take these substitutions into account.  Because the GDP deflator assumes substitutions, it may underestimate the impact of inflation when consumers do not (are not able to) substitute. The CPI may overestimate the impact of inflation when consumers do substitute.

Most government agencies and many private contracts use the CPI to determine a cost of living adjustments (COLA).  The Social Security Administration added a 5.8 percent COLA to Social Security benefits and SSI payments in January 2009, based on  the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of 2007 to the third quarter of 2008.  If there had been no increase in the CPI in that time period, there would have been no increase in benefits.

Inflation and Unemployment

Long-standing economic theory has assumed that there is a predictable trade-off between the impact of public policy decisions and economic change on inflation and unemployment. This theory, developed by New Zealand Economist William Phillips in 1958, was based on his observation of an inverse relationship between money wage changes (inflation) and unemployment in the British economy over a period of time. The "Phillips Curve" proposed that when unemployment is low, inflation tends to be high and when unemployment is high, inflation tends to be low.

The implication for policy makers was that "Keynesian" policies could be used to control unemployment and inflation. Increased spending can lower unemployment with the risk of a high rate of inflation.  Policy makers face the Phillips Curve trade-off. Today, policy makers who propose to use monetary policy (lower interest rates) or fiscal policy (deficit spending) to stimulate the economy, and increase GDP and employment, are aware of its potential inflationary effect. The Phillips Cure theory lost favor in the late 1980s when there were periods of both high unemployment and high inflation, followed in the 1990s by periods of low unemployment and low inflation.

One of the Federal Reserve System's (Fed) mandates is to maintain a stable price level and purchasing power.  The Fed recognized this potential trade-off in its most recent monetary policy statement when it justified an aggressive stimulatory policy by saying that the current conditions did not include an inflationary threat. Low inflation provides room for aggressive policies to stimulate the economy. Should inflation become a real threat, the Fed may slow down growth of the money supply.

[Teacher Note:  Ask students: Does the Phillips Curve make sense?  Does it apply in this recessionary period?]

ASSESSMENT ACTIVITY

CONCLUSION

Not long ago, many observers of the CPI thought a little inflationary pressure was back.  Some have predict a greater inflationary threat as a result of the Federal Reserve's "loose" money policies in recent years.  But, the CPI-U decreased March, primarily as a result of the fall in energy prices. Over the last year, the CPI-U increased just 1.5 percent before seasonal adjustment.  This is well below the Federal Reserve's goal of a 2.0 percent annual price level increase.

The inflation "wildcard" is, again this month, energy and food prices prices. Excluding energy and food, the "core" CPI-U, "all items less food and energy," increased 1.9 percent in the past twelve months.  Gasoline and food prices accounted for much of the all items price level decrease in March. The average gasoline price (all types) has bounced up and down over the past year, dropping 13 cents between March 2012 and March 2013.  [Note: Although not shown in the BLS data yet, gasoline prices have dropped significantly more in early April, 2013.]

For most of our spending categories, prices have been relatively stable, but the real story may be whether or not our incomes have kept up with prices and we can still purchase the same goods and services we did last year.  For many families, higher gasoline prices in recent years have meant giving up other consumption, so that they can drive to work or take a vacation.

Those who say that the "core" rate of inflation is a better long term measurement of the price level face criticism from many who have lived in an extended period of higher energy and food prices.

What do you think?

EXTENSION ACTIVITY

The BLS tracks a variety of international data, including prices. Take a look at some of the international data.

Go to, "Consumer Prices (CPI) 15 Countries ," (February 2012 to February 2103.)  Read the inflation data about the fifteen industrialized nations.

  • Do you see any patterns?
  • Which nations have had higher inflation rates than the U.S.? Lower rates?
  • What do you think may account for the differences?
     

Go to, "U.S. Import and Export Price Index, March 2013 ."  Read about the price changes for U.S. imports and exports.

"The price index for U.S. imports declined 0.5 percent in March, the U.S. Bureau of Labor Statistics reported today, following increases of 0.6 percent in February and 0.5 percent in January. The March decrease was primarily led by a downturn in fuel prices. U.S. export prices fell 0.4 percent in March after rising 0.7 percent in February."

  • How much have import and export prices changed compared to U.S. domestic prices?
  • What imported goods have had the greatest price increases recently? Exports?
  • Which nations' goods have increased in prices the most? Least?