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 October 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 4.3 percent.

In October, the core consumer price index, which excludes energy and food prices, also increased by 0.2 percent. The core index has increased by 2.1 percent over the last twelve months.

Have your students do the following multiple choice activity:

[Answer for teachers. Current inflation, at least the rate over the last 12 months, is higher than what it was since 2000.]

Information for Teachers

All paragraphs in italics will not appear in the student version of the inflation case study. The original press release can be found at .

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 continual increase in the overall level of prices. It is an increase in average prices that lasts at least a few months. The most widely reported measurement of inflation is the consumer price index (CPI). The CPI measures the cost of a fixed set of goods relative to the cost of those same goods in a previous month or year. Changes in the prices of those goods approximate changes in the overall level of prices paid by consumers.

Data Trends

In October, the Consumer Price Index increased by .2 percent, after increasing 1.2 percent in September and .5 percent in August. In October, housing prices increased, but transportation and apparel prices decreased. The prices of medical care increased during the month.

The .2 percent increase is the lowest monthly increase in prices since June.

The core rate of inflation (.2 percent) 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 October increase compares to a 0.1 percent increase in the core rate of inflation in each month since April when it did not change.

Have your students do the following multiple choice activity:

Figure 1 shows recent inflation data reported for each month. It is obvious that the monthly inflation figures change a great deal and that rates of inflation are not exactly stable from one month to the next. The rates appear to vary more beginning in 2003 through 2005.

Figure 1: Monthly Inflation in Consumer Prices at Monthly Rates

Figure 2 adds the core index in a dashed, red line. The core index does not vary as much as the CPI as oil and food prices have been particularly volatile in the last three years. 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.

Figure 2: Monthly Inflation in Consumer Prices at Montly Rate

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 for annual rates of inflation throughout that entire period. 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.

The Consumer Price Index

The seasonally adjusted consumer price index in October was 198.9. 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 October 2004 by almost 100 percent. That is they have almost doubled.

Inflation is usually reported in newspapers and television news as percentage changes in the CPI on a monthly basis. For example, the CPI in October was 198.9, compared to 198.5 in September. The increase in prices from September to October was (198.9-198.5) / 198.5 = 0.0020 or a monthly inflation rate of .2 percent. To convert this into an annual rate, you could simply multiply by 12. This approximates an annual inflation rate of (.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, which in this case gives the same result when rounded off.

Table 1
Month Price Level Monthly Inflation Rate Annual Inflation Rate
October 198.9
198.9 - 198.5 = + .002 or + .2%

198.5
 
September 198.5

How the CPI is Calculated

The CPI is based on prices of food, clothing, housing, transportation, and all the other goods and services that people purchase on a regular basis. Forty percent of those prices are prices of goods; sixty percent are prices of services.

Prices are collected through phone interviews and visits in almost 90 cities around the country. Almost 25,000 grocery stores, clothing stores, service stations, hospitals, and other retail stores are included. Fifty thousand families are interviewed.

For more information on the Bureau of Labor Statistics, visit ( ).

CPI Interactive Exercise

Have your students do the following multiple choice activity:

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. 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 facing consumers. 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.

Questions

Have your students do the following multiple choice activity:

[Answers to the online assessment activity:

  1. The correct answer is ‘c’. If income has increased by four percent and prices have increased by three percent, the difference is the increase in real income. Thus, real incomes have increased by one percent.
  2. The correct answer is ‘a’. GDP in current prices has increased by three percent. Prices have increase by five percent. Real output of goods and services must have fallen. Real GDP will have decreased by two percent.
  3. The correct answer is ‘a’. Average income has increased by 20 percent. Prices have increased by 10 percent [(220 – 200) / 200]. Thus real income must have increased by approximately 10 percent.
  4. The correct answer is ‘d’. Prices have doubled. Thus, in 2006 dollars, the price of movie tickets would now be $10.00.]

Answers to go with other questions.

  1. What is inflation?

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

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

    Item

    Quantity

    Price

    December, 2004

    DVDs

    2

    $ 17.00

    Hamburgers

    5

    $ 3.00

    Socks

    5

    $ 4.00

    New clothing

    1 complete set

    $ 50.00

    December, 2005

    DVDs

    3

    $ 14.00

    Hamburgers

    6

    $ 4.00

    Socks

    4

    $ 4.50

    New clothing

    1 complete set

    $ 60.00

    1. What is the price index for December, 2005 (with a base period of December, 2004)?

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

    2. What is the price index for December, 2005 (with a base period of December, 2004)?

      [The price index for December, 2005 is equal to 109.7. To calculate the December, 2005 price index with a base period of December, 2004, the 2004 quantities multiplied by the 2005 prices are divided by the 2004 quantities multiplied by the 2005 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?

    [The rate of increase in prices from over the year can be calculated by dividing the increase in the index by the initial level of the index. (These indexes show a much higher rate of inflation than the actual.)

    That is (170 - 150) / 150 = .133 or 13.3 percent. Because this is over a twelve-month period, it is an annual rate of inflation. More difficult interpretations are based on single month changes. The results are normally converted to annual rates of inflation.]

  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. Given the following data, calculate the rate of inflation between 2001 and 2002.
    CPI   Average per capita disposable income
    1998 163.0 1998 $ 23,037
    1999 166.6    
    2000 172.2    
    2001 177.1 2001 $ 25,957
    2002 179.9    

    [1.6 percent. 179.0 / 177.1 = 1.016 or an increase of 1.6 percent.]

  6. Given the above data, calculate the average rate of inflation between 1998 and 2002.

    [2.6 percent. 179.9 / 163 = 1.104 or an increase of 10.4 percent. The annual average increase can be approximated by dividing 10.4 percent by four (years) and thus get 2.6 percent per year.]

  7. Using the above data, calculate average real income in 1998 and 2001. Did real per capita income increase or decrease from 1998 to 2001?

    [The real incomes, in 1982-1984 dollars, are calculated as follows:
    Real income in 1998 = $23,037 / 1.630 = $14,133.
    Real income in 2001 = $25,957 / 1.771 = $14,657.

    Yes, real income did increase, but not by almost $3,000, the difference between the nominal incomes.]