Explore the connection between the economic indicators and real-world issues. These lessons typically can be done in one class period.
Current Key Economic Indicatorsas of November 10, 2014
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.
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.
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.
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.
The consumer price index (CPI) during the month of September increased by 1.2 percent. The rate of increase in the consumer price index over the past twelve months has been 4.7 percent.
In September, the core consumer price index, which excludes energy and food prices, increased by .1 percent (one-tenth of one percent). The core index has increased by 2.0 percent over the last twelve months.
Have your students do the following multiple choice activity:
[Answer for teachers. The core index excludes changes in food and energy prices. Thus if the CPI and the core index increased, but the CPI increased by a significantly larger amount, it must be that food or energy prices increased at a much faster pace. (In fact, energy prices increased by an unusually rapid rate (12 percent) and food prices increased by 1.9 percent.)
A follow-up discussion question might be to ask what the relationship between the two measures has been over the last 12 months. Ask students to explain.
The answer is that the CPI has increased by 4.7 percent and the core by 2.0 percent over the last 12 months. Thus, food and energy prices together must have increased by more than the prices of all other goods. Energy prices have been the cause – a very large increase of 34.8 percent over the last 12 months]
Information for Teachers
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 compares the prices of a set of goods and services relative to the prices 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.
The core consumer price index is the average price of the same set of goods and services, without including food and energy prices, relative to the price of the set without food and energy prices in a previous month or year.
In September, the consumer price index increased by 1.2 percent, after increasing .5 percent in each of the previous two months. In September, energy prices increased rapidly for the month in a row. Price indexes for transportation also rose.
The annual rate of increase over the last three months was 9.4 percent and over the last 12 months, 4.7 percent. Annual inflation rates during all of 2002, 2003, and 2004 were 2.4, 1.9 and 3.3 percent.
While a number of news stories will focus on the rather rapid increase in the consumer price index, we should be cautious about placing too much emphasis on any one month change.
The core rate of inflation (increased by .1 percent in September) represents changes in 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 increased September index compares to a .1 percent increase in the core rate of inflation in each of the previous five months. Core prices increased more slowly in the last three months than the overall index due to the rapid rises in prices of energy. The annual rate of increase in prices of energy over the last three months was 122 percent.
Extra attention is given by forecasters to the core index as it tends to show more lasting trends in prices. This month’s results provide some evidence that the increase in energy prices has not significantly influenced rates of increases in all other prices. Still the rapid rise in energy prices may eventually have a significant effect on all other prices in the economy.
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 five months. It is however difficult to tell what the trend over a longer period of time has been.
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, prior to this month, as high and they are not, when compared to those of the past thirty years. However, the recent rates have been increasing and that has caused some concern. See the most recent Federal Reserve case study and the exercises at the end of this case.
The Consumer Price Index
The seasonally adjusted consumer price index in September was 198.8. The price index was equal to 100 during the period from 1982 to 1984. The appropriate interpretation of the index is that prices in the market basket of goods and services purchased by the typical consumer increased from the 1982-1984 period to September 2005 by 98.8 percent. A typical consumer good that cost one dollar in 1983 now costs almost $2.00.
Inflation is announced and reported in newspapers and television news as percentage changes in the CPI on a monthly basis. For example, the CPI in September was 198.8, compared to 196.4 in August. The increase in prices from August to September was (198.8 – 196.4) / 196.4 = + 0.012. That means a monthly inflation rate of 1.2 percent.
To convert this into an approximate annual rate, you can simply multiply by 12. This provides us an annual inflation rate of (1.2) (12) = 14.4 percent.
|Month||Price Level||Monthly Inflation Rate|
How the CPI is Calculated
Assume that there are only three goods (instead of goods and services in over 200 categories in the actual calculation) included in the typical consumer’s purchases and, in the base or the original year, the goods had prices of $10.00, $20.00, and $30.00. The typical consumer purchased ten of each good.
In the current year, the goods’ prices are $11, $24, and $33. Consumers now purchase 12, 8, and 11 of each good.
The CPI for the current year would be the quantities purchased in the market basket in the base year (ten of each good) times their prices in the current year divided by the quantities purchased in the market basket in the base year times their prices in the base year.
Thus [ (10 x $11) + (10 x $24) + (10 x $33)] / [( 10 x $10) + (10 x $20) + (10 x $30)] = $680 / $600 = 1.133. That is, prices in the current year are 1.133 times the prices in the original year. Prices have increased on average by 13.3 percent. The quantities are the base year quantities in both the numerator and the denominator.
By convention, the indexes are multiplied by 100 and reported as 113.3 instead of 1.133.
The base year index simply divides the prices in the base year (times the quantities in the base year) by the prices in base year (times the quantities in the base year). The base-year index then is 1.00; or multiplied by 100 equals 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, other transportation prices, medical, dental, and legal services and hundreds of other 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 in the sample.
Almost 80,000 prices in 87 urban areas across the country are sampled by Bureau of Labor Statistics professionals. Visits and phone calls are made to thousands of households and thousands of retail stores and offices.
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. The relative importance of each of the categories of goods and services that included in the market basket are as follows.
|Housing||42 %||Recreation||6 %|
|Transportation||17 %||Education and communication||6 %|
|Food and beverages||15 %||Clothing||4 %|
|Medical care||6 %||Other goods and services||4 %|
CPI Interactive Exercise
Suppose a sandwich at the local fast food restaurant costs $5. If the price index is 194.1 now, approximately how much did that sandwich cost in 1983 (the base year) if sandwich prices changed at the same rate as all other prices?
Have your students do the following multiple choice activity:
[The correct answer is increased. There are two primary ways to make the calculation. Prices have almost doubled. Income has more than doubled. Thus, real income has increased as prices have increased by less than nominal (using current prices) income.
A second method is that one could divide the current nominal income by 1.988 to get the current income in 1983 dollars. That is the real income. The result is that the current real income is $22,636. Thus real income has increased from $20,000 to $22,636. ]
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.
A Note on Seasonally Adjusted and Unadjusted Data
"Because price data are used for different purposes by different groups, the Bureau of Labor Statistics publishes seasonally adjusted as well as unadjusted changes each month. For analyzing general price trends in the economy, seasonally adjusted changes are usually preferred since they eliminate the effect of changes that normally occur at the same time and in about the same magnitude every year--such as price movements resulting from changing climatic conditions, production cycles, model changeovers, holidays, and sales.
The unadjusted data are of primary interest to consumers concerned about the prices they actually pay. Unadjusted data also are used extensively for escalation purposes. Many collective bargaining contract agreements and pension plans, for example, tie compensation changes to the Consumer Price Index unadjusted for seasonal variation." ( )
If the annual rate of inflation is 4 percent a year and average income increases by 3 percent, what has happened to real average income?
- Decreased by 1 percent
- Decreased by 3 percent
- Increased by 1 percent
- Increased by 3 percent
- Increased by 7 percent
[The correct answer is ‘a’. If income has increased by three percent and prices have increased by four percent, real incomes have had to decrease. An approximation is that real incomes have decreased by one percent.]
Suppose the CPI was 100 one year, and was 105 the next year. What is the approximate annual rate of inflation for those 12 months?
- 5 percent
- 10 percent
- 10.5 percent
- 105 percent
[The correct answer is ‘a’. The rate of increase in prices over the year can be calculated by dividing the increase in the index by the initial level of the index.
That is (105 - 100) / 100 = .05 or 5 percent. That is an increase of 5 is 5 percent of a starting year index of 100. Because this is over a twelve-month period, it is an annual rate of inflation.]
Suppose the CPI was 200 in one year and 220 in the next year. What was the annual rate of inflation for those 12 months?
- 5 percent
- 10 percent
- 20 percent
- 120 percent
- 220 percent
[The correct answer is ‘b’. Prices have increased 10 percent. The change in the index is 20. The initial year is 200. Thus the annual inflation is 20 / 200 or 10 percent.]
Suppose a bicycle cost $200 in 1983 and a similar new bicycle costs $500? Given what you know about current price indexes, has the real cost of the bicycle increased or decreased?
- stayed the same
- one cannot tell.
[The correct answer is ‘a’. Prices have approximately doubled. The price of the bicycle has more than doubled. Thus, the real cost of the bicycle, the price in 1983 dollars, has increased.]
An automobile costs $15,000 in 1983. It costs $35,000 this year. What has happened to the price in 1983 dollars?
- not changed
- one cannot tell.
[The correct answer is‘d’. Average prices have approximately doubled. The price of the automobile has more than doubled. Thus the price, in 1983 dollars, has increased. However, if the quality has increased than the automobile is not the same product and comparisons of prices are much more difficult. It may be that the automobile’s price in 1983 dollars has actually decreased once we adjust for the improvement in quality.]