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Announcement

The consumer price index (CPI) during the month of March increased by .6 percent (six-tenths of one percent). The rate of increase in the consumer price index over the past twelve months has been 3.1 percent.

In March, the core consumer price index, which excludes energy and food prices, increased by 0.4 percent. The core index has increased by 2.3 percent over the last twelve months.

Please do the following multiple choice activity:

Table 1
Month Price Level Monthly Inflation Rate Annual Inflation Rate
March 193.2
 193.2 - 192 = .00625 or .6% 192
1.0062512 = 1.078 or 7.8 %
February 192

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 set of goods and services relative to the cost of those same goods and services in a previous month or year. Changes in the prices of those goods and services approximate changes in the overall level of prices paid by consumers.

Data Trends

In March, the Consumer Price Index increased by .6 percent, after increasing .4 percent in February and increasing by .1 percent in January. In March, increases in transportation costs and apparel were largely responsible for the overall increase. Increases in prices of energy accounted for almost half of the increase. The prices of housing and medical care also increased during the month.

The .6 percent increase is the most rapid monthly increase in prices since last October. The annual rate of increase over the last three month was 3.1 percent and over the last 12 months, 4.3 percent. Annual inflation rates during all of 2002, 2003, and 2004 were 1.6, 2.3 and 2.7 percent.

The core rate of inflation (.4 percent in March) 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 March increase compares to a .3 percent increase in the core rate of inflation in February and .2 percent in January. Core prices increased more slowly in those months than the overall index due to the rapid rises in prices of energy.

Extra attention is given by forecasters to the core index as it tends to show more lasting trends in prices.

Figure 1 shows recent inflation data reported for each month. It is obvious that the monthly inflation figures change a great deal from one month to the next. However, the trend has been an increasing trend over the last four months.

Figure 2 shows annual rates of inflation from the 1970s to now. Compared to the rates of inflation in the 1970s and much of the 1980s, the current rate of inflation is low. Few observers would describe the most recent rates as high and they are not, when compared to those of the past thirty years. Even though recent rates have increased slightly, the U.S. economy is experiencing inflation that is significantly below what is possible.

The Consumer Price Index

The seasonally adjusted consumer price index in March was 193.2. The price index was equal to 100 during the period from 1982 to 1984. The interpretation is that prices in the market basket of goods and services purchased by the typical consumer increased from the 1982-1984 period to March 2004 by 93.2 percent. A typical consumer good that cost one dollar in 1983 now costs \$1.93.

Inflation is usually reported in newspapers and television news as percentage changes in the CPI on a monthly basis. For example, the CPI in March was 193.2, compared to 192.0 in February. The increase in prices from February to March was (193.2 – 192.0) / 192.0 = 0.00625 or a monthly inflation rate of .625 percent. It is reported to the nearest one-tenth of a percent, in this case, .6 percent. To convert this into an annual rate, you could simply multiply by 12. This approximates an annual inflation rate of (.6) (12) = 7.2 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 12 th power. The result is an annual rate of inflation of 7.8 percent.

Table 1
Month Price Level Monthly Inflation Rate Annual Inflation Rate
March 193.2
 193.2 - 192 = .00625 or .6% 192
1.0062512 = 1.078 or 7.8 %
February 192

How the CPI is Calculated

Assume that there are only two goods included in the typical consumer's purchases and, in the base or original year, each goods costs \$10.00. Each consumer purchases one of each good.

In the current year, the goods cost \$11 and \$12. The index for the current year would be the quantities purchased in the market basket (one each of each good) times their prices in the current year divided by the quantities purchased in the market basket times their prices in the base year.

Thus ( 1 x \$11 + 1 x \$12 ) / ( 1 x \$10 + 1 x \$10 ) = \$23 / \$20 = 1.15. That is, prices in the current year are 1.15 times those prices in the original year. Prices have increased on average by 15 percent. That is true. The price of one good increased by 10 percent. The price of the second good increased by 20 percent. By convention, the indexes are multiplied by 100 and reported as 115 instead of 1.15.

The base year index simply divides the prices in the base year by the prices in base year. The index then is 100.

How the CPI Data are Collected

The Bureau of Labor Statistics samples the purchases of households representing 87 percent of the population. 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.

Goods and services sampled include food, clothing, housing, gasoline, transportation, medical, dental, and legal services and hundreds of retail goods and services. Taxes associated with the purchases are included. Each item is weighted in the average according to its share of the spending of the households included. Almost 100 urban areas are sampled by Bureau of Labor Statistics professionals including visits and phone calls to 50,000 households and almost 25,000 retail stores and offices.

For more information on the Bureau of Labor Statistics, visit [EEL-link id='1222' title='www.bls.gov' ] .

Please do the following multiple choice activity:

Causes of Inflation

Please do the following multiple choice activity:

Over short periods of time, inflation can be caused by increases in costs or increases in spending. Inflation resulting from an increase in aggregate demand or total spending is called demand-pull inflation . Increases in demand , particularly if production in the economy is near the full-employment level of real GDP, pull up prices. It is not just rising spending. If spending is increasing more rapidly than the capacity to produce, there will be upward pressure on prices.

Inflation can also be caused by increases in costs of major inputs used throughout the economy. This type of inflation is often described as cost-push inflation . Increases in costs push prices up. The most common recent examples are inflationary periods caused largely by increases in the price of oil. Or if employers and employees begin to expect inflation, costs and prices will begin to rise as a result.

Over longer periods of time, that is, over periods of many months or years, inflation is caused by growth in the supply of money that is above and beyond the growth in the demand for money.

Inflation, in the short run and when caused by changes in demand, has an inverse relationship with unemployment. If spending is rising faster than capacity to produce, unemployment is likely to be falling and demand-pull inflation increasing. If spending is rising more slowly than capacity to produce, unemployment will be rising and there will be little demand-pull inflation.

That relationship disappears when inflation is primarily caused by increases in costs. Unemployment and inflation can then rise simultaneously.

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.

Self-tests for understanding data.

Please do the following multiple choice activity: