Explore the connection between the economic indicators and real-world issues. These lessons typically can be done in one class period.

KEY CONCEPTS

Consumer Economics, Consumer Price Index (CPI), Consumers, Deflation, Full Employment, Inflation, Monetary Policy, Money, Unemployment

Current Key Economic Indicators

as of May 5, 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

Total nonfarm payroll employment rose by 165,000 in April, and the unemployment rate was little changed at 7.5 percent. Employment increased in professional and business services, food services and drinking places, retail trade, and health care.

Real GDP

Real gross domestic product increased at an annual rate of 2.5 percent in the first quarter of 2013 (that is, from the fourth quarter to the first quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 0.4 percent.

Federal Reserve

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. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent...


Announcement

The consumer price index (CPI) during the month of December 2003 increased by .2 percent (two-tenths of one percent). The rate of increase in the consumer price index over the past twelve months has been 1.9 percent.

In December, the core consumer price index, which excludes energy and food prices, increased by .1 percent. The core index has increased by 1.0 percent over the last twelve months.

Information for Teachers

All paragraphs in italics will not appear in the student version of the inflation case study. This case builds upon the previous inflation case study. More advanced concepts and questions will be added throughout the fall semester.

The original press release can be found at www.bls.gov/news.release/cpi.nr0.htm .

This lesson uses several charts and tables. You may use these files to create student reproducables or overhead transparencies for use in your classroom.

Goals of the Case Study

The goals of the Inflation Case Studies are to provide teachers and students:

  • access to easily understood, timely interpretations of monthly announcements of rate of change in prices in the U.S. economy;
  • descriptions of major issues surrounding the data announcements;
  • brief analyses of historical perspectives;
  • questions and activities to use to reinforce and develop understanding of relevant concepts; and
  • a list of publications and resources that may benefit classroom teachers and students interested in exploring inflation.

Definitions of Inflation

Inflation is a sustained increase in the overall level of prices. The most widely reported measurement of inflation is the consumer price index (CPI). The CPI measures the cost of a fixed basket of goods relative to the cost of that same basket of goods in a base (or previous) year. Changes in the price of this basket of goods approximate changes in the overall level of prices paid by consumers.

Data Trends

In December, the Consumer Price Index increased by .2 percent, after decreasing .2 percent in November, and not changing in October. For the last quarter of the year, the rate of change was equal to zero. In December, increases in food and medical care prices contributed to the increase.

Table 1
Rate of Change in the Consumer Price Index
(from December to December)
1994 1995 1996 1997 1998 Average 1994 to 1998
2.6% 2.5% 3.3% 1.7% 1.6% 2.3%
1999 2000 2001 2002 2003 Average 1999 to 2003
2.7% 3.4% 1.6% 2.4% 1.9% 2.4%

The core rate of inflation (+ .1 percent in December) represents the consumer price index without the influences of changes in the prices of food and energy, which can fluctuate widely from month to month. The December increase compares to a 0.2 percent increase in the core rate of inflation in October and a 0.1 percent decrease in November. Core prices actually increased more slowly this month than the overall index because food price increases were such a large part of the overall increase.

Figure 1 below shows recent inflation data reported for each month. Inflation increased in 1999 and 2000 when compared to1998, slowed throughout much of 2001, then increased slightly in 2002, and slowed slightly in 2003. What is really quite obvious from Figure 1 is that the changes in inflation from month to month are much more dramatic from 1999 on, when compared to 1998. The increased volatility is primarily due to fluctuations in the prices of oil and food. The core rate of inflation (excluding food and energy) gives a much better idea of longer-term trends and that is why it is often featured in news reports. See figure 2.

Figure 1: Monthly Inflation in Consumer Prices at Annual Rates

Figure 2: Monthly Core Inflation Rate (excludes food and energy) at Annual Rates

Compared to the rates of inflation in the 1970s and much of the 1980s, the current rate of inflation is quite low. See figure 3 below. The very high rates of inflation in the early and late 1970s were accompanied by very rapid rises in prices of oil. Few observers would describe the most recent rates as high and they are not, when compared to those of the past thirty years. Other observers would describe the current experience as no or zero inflation.

Figure 3: Inflation in Consumer Prices since 1970

The Consumer Price Index

The seasonally adjusted consumer price index in December was 185.0. The price index was equal to 100 during the period from 1982 to 1984. The interpretation is that prices in market basket of goods purchased by the typical consumer increased from the 1982-1984 period to December 2003 by 85 percent.

Inflation is usually reported in newspapers and television news as percentage changes in the CPI on a monthly basis. For example, the CPI in December was 185.0, compared to 184.6 in November. The increase in prices from November to December was (185 -184.6) / 184.6 = 0.0022 or a monthly inflation rate of 0.22 percent. It is reported to the nearest one-tenth of a percent, in this case, 0.2 percent. To convert this into an annual rate, you could simply multiply by 12. This approximates an annual inflation rate of (0.2) (12) = 2.4 percent. A slightly more accurate measurement of the annual inflation rate is to compound the monthly rate, or raise the monthly rate of increase, plus one, to the 12th power.

How the Annual Inflation Rate is Calculated

Month

Price Level

Monthly Inflation Rate

Annual Inflation Rate

December 185.0
185.0-184.6

= .0022 or .2 %


184.6

1.002212 = 1.0267
or a 2.7 % increase in prices

November 184.6

How the CPI Data are Collected

"The Consumer Price Index (CPI) is a measure of the average change in prices over time of goods and services purchased by households. The CPI is based on prices of food, clothing, shelter, and fuels, transportation, fares, charges for doctors' and dentists' services, drugs, and other goods and services that people buy for day-to-day living.

“Prices are collected in 87 urban areas across the country from about 50,000 housing units and approximately 23,000 retail establishments - department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments. All taxes directly associated with the purchase and use of items are included in the index. Prices of fuels and a few other items are obtained every month in all 87 locations.

“Prices of most other commodities and services are collected every month in the three largest geographic areas and every other month in other areas. Prices of most goods and services are obtained by personal visits or telephone calls of the Bureau's trained representatives.” For more information on the Bureau of Labor Statistics, visit ( www.bls.gov ).

Costs of Inflation

Understanding the costs of inflation is not an easy task. There are a variety of myths about inflation. There are debates among economists about some of the more serious problems caused by inflation. A number of exercises in National Council on Economic Education publications, student workbooks, and textbooks should help students think about the consequences of inflation.

  1. High rates of inflation mean that people and business have to take steps to protect their financial assets from inflation. The resources and time used to do so could be used to produce goods and services of value. Those goods and services given up are a true cost of inflation.
     
  2. High rates of inflation discourage businesses planning and investment as inflation increases the difficulty of forecasting of prices and costs. As prices rise, people need more dollars to carry out their transactions. When more money is demanded, interest rates increase. Higher interest rates can cause investment spending to fall, as the cost of investing increases. The unpredictability associated with fluctuating interest rates makes customers less likely to sign long-term contracts as well.
     
  3. The adage "inflation hurts lenders and helps borrowers" only applies if inflation is not expected. For example, interest rates normally increase in response to anticipated inflation. As a result, the lenders receive higher interest payments, part of which is compensation for the decrease in the value of the money lent. Borrowers have to pay higher interest rates and lose any advantage they may have from repaying loans with money that is not worth as much as it was prior to the inflation.
     
  4. Inflation does reduce the purchasing power of money.
     
  5. Inflation does redistribute income. On average, individuals' incomes do increase as inflation increases. However, some peoples' wages go up faster than inflation. Other wages are slower to adjust. People on fixed incomes such as pensions or whose salaries are slow to adjust are negatively affected by unexpected inflation.

Other Measures of Inflation

The GDP price index (sometimes referred to as the implicit price deflator). The GDP price index is an index of prices of all goods and services included in the gross domestic product. Thus the index is a measure that is broader than the consumer price index.

The producer price index . This index measures prices at the wholesale or producer level. It can act as a leading indicator of inflation. If the prices producers are charging are increasing, it is likely that consumers will eventually be faced with higher prices for good they buy at retail stores.

A Market Basket of Goods and Services

The Consumer Price Index measures prices of goods and services in a market basket of goods and services that is intended to be representative of a typical consumer's purchases. Forty-one percent of the market basket is made up of goods that consumers purchase. The other fifty-nine percent includes services.

Using the CPI as an Inflation Index

The Social Security Administration announced on October 16 that Social Security payments, beginning at the end of December, 2003, will increase by 2.1 percent. Annual changes in Social Security payments are based on changes in the consumer price index. The rate of change in consumer prices from October of one year through September of the next is used to calculate the appropriate change in the Social Security payments for the following year. The purpose of the adjustment is to maintain the real purchasing power of the Social Security payments, that is, to reduce the cost of inflation for those who might otherwise be living on fixed incomes.

Income tax brackets and deductions also change according to changes in the consumer price index. Private contracts often also reference changes in inflation as measured by the consumer price index.

Using the CPI

  1. Given the following data, calculate the total inflation between 2000 and 2003.
    Average income in your community
    2000 $ 40,000
    2001 $ 41,000
    2002 $ 42,000
    2003 $ 43,000
    CPI
    2000 174.6
    2001 177.3
    2002 181.6
    2003 185.0
    [6.0 percent. 185 / 174.6 = 1.0596 or an increase of 6 percent.]
  2. Given the above data, what has happened to real income in your community from 2000 to 2003?
    [Average income has gone up 7.5 percent. $43,000 / $40,000 = 1.075 or an increase of 7.7 percent. Because average income has increased by a larger percentage than the price level, the average “real” income has increased by approximately 1.5 percent.]
     
  3. Are people better off or worse off? Why?
    [If these figures are accurate, people in this community are slightly better off. That is, their incomes will buy 1.5 percent more than they would in 2000.]

Questions for Students

  1. What is inflation?
    [A continual increase in the average price level. The important points are that most prices or average prices rise and that the increase continues and is not just a one-time increase.]

  2. Calculate price indexes for the following a hypothetical secondary student’s budget.

     

    December, 2002

    Item

    Quantity

    Price

    DVDs

    2

    $ 17

    Hamburgers

    5

    $ 3

    Socks

    5

    $ 4

    New clothing

    1 complete set

    $ 50

    December, 2003

    DVDs

    3

    $ 14

    Hamburgers

    6

    $ 4

    Socks

    4

    $ 4.50

    New clothing

    1 complete set

    $ 60

     


    1. What is the price index for December, 2002 (with a base period of December, 2002)?
      [The price index for December, 2002 is equal to 100. The quantities for 2002 are multiplied by the 2002 prices. Then the quantities for 2002 are multiplied by the 2003 prices. To calculate the December, 2002 price index with a base period of that month, the 2002 quantities multiplied by the 2002 prices are divided by the 2002 quantities multiplied by the 2002 prices and then the result is multiplied by 100.]

    2. What is the price index for December, 2003 (with a base period of December, 2002)?
      [The price index for December, 2003 is equal to 109.7. To calculate the December, 2003 price index with a base period of December, 2002, the 2002 quantities multiplied by the 2003 prices are divided by the 2002 quantities multiplied by the 2002 prices and then the result is multiplied by 100.]

    3. What is the rate of inflation over the year?
      [The annual rate of inflation over the period is 9.7 percent. (The index for December 2003 minus the index for December 2003, given that the first index is the base year.)]

  3. Suppose the CPI was 150 for July of one year, and was 170 for July of the next year. What is the corresponding annual rate of inflation?
    [125. The price index is calculated by first taking the 2002 quantities times the 2002 prices. The 2003 prices are then multiplied by the 2002 quantities. Then the latter (the amount spent if only the prices change) is divided by the 2002 prices times 2002 quantities and multiplied by 100. ($25/$20) x 100 = 125. The most common mistake will be to calculate the second year with the 2003 prices and 2003 quantities.]

  4. The base year of the CPI is 1982-1984. What has happened to prices since 1970 if the 1970 index was approximately 80 and if the current CPI were 160?
    [A current level of 160 would mean that consumer prices on average are 100 percent higher than their 1970 levels. The percentage increase is (160 - 80) / 80 = 1 or 100 percent. The base year period is not relevant to the calculation.]
     
  5. If prices increase by five percent in a year, what effect does this have on the purchasing power of individuals in the economy?
    [Students may answer that purchasing power goes down since their money is worth less, and consequently they cannot buy as many goods and services. The value of money does fall. However, they are ignoring that inflation affects wages as well. If average incomes and prices of goods and services have increased by five percent, the purchasing power of average income remains unchanged.]