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

KEY CONCEPTS

Consumer Price Index (CPI), Costs, Fiscal Policy, Full Employment, Inflation, Monetary Policy, Real Gross Domestic Product (GDP), Unemployment

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.


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.

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 2.8 percent.

In March, 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 2.5 percent over the last twelve months.

[The answer is that the CPI has increased by 2.8 percent and the core by 2.5 percent over the last 12 months. The core index excludes changes in food and energy prices. Thus, the only change that can cause the more rapid increase in the overall index is a faster increase in food and energy prices. Food and energy prices together must have increased by more than the prices of all other goods.  

Energy prices have been the real cause – an increase of 4.4 percent over the last 12 months. (Food prices increased by 3.3 percent.)]

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 . Goals of 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 same goods and services without food and energy prices in a previous month or year.

Data Trends

In March, the consumer price index increased by .6 percent, after increasing .4 percent in February.

The annual rate of change over the last three months was 4.7 percent and over the last 12 months, an increase of 2.8 percent. Annual inflation rates during all of 2004, 2005, and 2006 were 3.3, 3.4 and 2.5 percent.

Recent news stories have focused on the rapid increases in energy. Both food and energy prices have been rising rapidly pulling the overall CPI index up.

The core rate of inflation (increased by .1 percent in March) 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 March index compares to a .2 percent increase in the core rate of inflation in February and .3 percent in January. 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 over the last several years 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 few 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 March was 205.146. 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 March 2006 by 105.146 percent. A typical consumer good that cost one dollar in 1983 (the middle of the 1982 to 1984 period) now costs almost $2.05.

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 March was 205.146, compared to 203.906 in February. The increase in prices from February to March was (205.146 – 203.906) / 203.906 = .006. That means a monthly inflation rate of .6 percent.

To convert this into an approximate annual rate, you can simply multiply by 12. This provides us an annual deflation rate of (.6) (12) = 7.2 percent. (The rate of increase in the overall index was quite high.)

Month

Price Level

Monthly Inflation Rate

March 205.146 205.146 - 203.906 = .006 or .6% 203.906
February 203.906

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 percent of the market basket is made up of goods that consumers purchase. The other sixty percent is 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.

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

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

43%

Recreation

6%

Transportation

17%

Education and communication

6%

Food and beverages

15%

Clothing

4%

Medical care

6%

Other goods and services

3%

CPI Interactive Exercise

Causes of Inflation

[1.The correct answer is increased. Again there are two ways to arrive at the answer. Prices increased by 5 percent. GDP increased by 10 percent. Therefore, real GDP increased by 5 percent.

A more exact calculation is to calculate real GDP in both cases. In the first year, real GDP equals $10 trillion / 2.00 = $5 trillion in the base year's dollars or prices. In the second year, real GDP equals $11 trillion / 2.1 = $5.24 trillion.]

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