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This lesson focuses on the Consumer Price Index (CPI) and rate of inflation reported December 15, 2010, by the U.S. Bureau of Labor Statistics (BLS) for the month of November, 2010. Students read the BLS report, analyze the meaning of the CPI data, determine the change in consumer prices, and explore the impact of the change in the price level on themselves, their families, consumers, and producers.

KEY CONCEPTS

Consumer Price Index (CPI), Inflation, Macroeconomic Indicators, Price Stability

STUDENTS WILL

  • Identify the current level, rate of change, and recent changes in the consumer price index.
  • Identify the factors that have influenced recent changes in the rate of inflation.
  • Identify the potential policy implications of the current economic conditions, including deflation.
  • Describe how inflation and deflation impact individuals, families, and different groups in the economy.

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...

INTRODUCTION

Each month, the U.S. Bureau of Labor Statistics (BLS) releases an estimate of the level of the consumer price index (CPI) and the rate of inflation in the United States for the previous month. The report provides the most recent current and seasonally adjusted consumer price indexes for all urban consumers, urban wager earners, and the chained index, plus a breakdown by major expenditure groups. The BLS also collects price level data for major metropolitan areas and regions.

This lesson focuses on the December 15, 2010, BLS press release of data on the consumer price index for the month of November, 2010.

[Note to teacher: You can subscribe to receive monthly BLS email news releases. To subscribe, go to the BLS News Service Subscription Page .]


[Note to teacher: For the latest updates on U.S. economic indicators, go to:

Note on the CPI and Inflation "Focus on Economic Data" Lessons:

During the first semester of this school year (September-January), EconEdLink will publish four lessons on "Consumer Price Index and Inflation." During this time period, the Focus on Economic Data will begin with the "basics" in September and progressively focus on more complex data, issues, and comparisons. All monthly lessons will include the current data and significant recent changes.

  • September: CPI and inflation (deflation) basics: What is the CPI? What is inflation and deflation? How are they measured? What do they mean?
  • October: Details and issues about the measurements and meaning of the measurements of the price level, adding additional concepts.
  • November: Detailed breakdown of the data by region and other criteria (trends, identifying trends and comparisons of regions and demographic groups).
  • December: The relationships of CPI and inflation data to other economic data, such as GDP, employment. etc. and the business cycle.]

MATERIALS

  • BLS "Focus on Spending and Prices":  These quarterly reports highlight recent trends in inflation and spending in the U.S. economy.
    www.bls.gov/opub/focus/

Key Economic Indicators

as of December 15, 2010

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.1 percent before seasonal adjustment.

Employment and Unemployment

The unemployment rate edged up to 9.8 percent in November, and nonfarm payroll employment was little changed (+39,000), the U.S. Bureau of Labor Statistics reported today. Temporary help services and health care continued to add jobs over the month, while employment fell in retail trade. Employment in most major industries changed little in November.

Real GDP

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.5 percent in the third quarter of 2010, (that is, from the second quarter to the third quarter), according to the "second" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.7 percent.

Federal Reserve

The FOMC will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

PROCESS

We see prices everyday of our lives. We see big prices like $25,000 for a new car and we see small prices like an 89 cent fast-food hamburger.  When the new model of the car goes up to $26,000 we may not realize it, but when the hamburger goes up to 99 cents we do.  When we get used to paying a particular price for something, it disturbs us when the price changes, but we can usually find a substitute.  If we purchase a particular item more often, we may be more aware when the price changes.

Take gasoline, for example.  It is, maybe, the one product where we see the price every day. Gasoline prices are posted for all to see.  Some people look for the lowest price and select a gas station.  Others may be loyal to a brand and choose to pay a little more for their brand.  But unlike gasoline, most prices take a little more work to find.  We have to go into the store and look for them.  We may have to shop around at several stores to find a lower price for something we want.  For everyday purchasing decisions, product prices are good information that helps us make choices.

Prices help us use our income to make decisions about the things we want - what to buy and what not to buy.  When all prices (or most) increase and we experience the effects of inflation (an increase in the average price level in the economy) we face other decisions. We may have to make difficult choices, giving up some things to have others.  Inflation - a rising rice level - erodes the purchasing power of our incomes and threatens our lifestyles.  A falling price level - called deflation - sounds great, but may also have a harmful impact on the economy

Is inflation or deflation an issue today?  Are prices increasing?  Are they falling? Let's see what the Bureau of Labor Statistics has to say about consumer prices in November, 2010.

U.S. Bureau of Labor Statistics Announcement
Consumer Price Index (CPI-U): November 2010
Released December 15, 2010

"The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.1 percent before seasonal adjustment."

The general price level increased just slightly in November, probably not enough for most to notice.  For the year, the price level increased just 1.1 percent - meaning that a typical market basket of goods and services we purchased for $100 in November of 2009 cost us $101.10 in November of 2010.  $1.10 may not be enough for us to notice.  Unless, of course, you make a living driving an automobile or a truck and you paid 7.3 percent more for gasoline in November 2010 than you did in November 2009. 

A "wildcard" like energy and food - products that tend to fluctuate more widely in price - will affect people differently, based on their consumption habits.  Did those who complained about gasoline prices in November notice when the price dropped over 5 percent in May?

When the BLS  reports on prices, it provides two basic numbers.  One is the CPI-U, including a broad variety of goods and services.  This measure of the price level is often referred to as the "headline" number.

The second number is referred to as the "core" rate of inflation and excludes energy and food prices that tend to fluctuate more.  Excluding food and energy is assumed to provide a better picture of the general price level over time.  The BLS uses the term "all items less food and energy" for this data.

From the BLS report: "The indexes for food, energy, and all items less food and energy all increased slightly in November. The index for food at home rose in November after being unchanged in October, with the indexes for eggs and nonalcoholic beverages both rising notably. Although the index for gasoline rose, the index for household energy declined and the increase in the energy index was the smallest in five months."

Though the price levels for some food and energy categories increased in November, other categories decreased, and the net result was a "modest" rise in the price level.

"The index for all items less food and energy rose in November after being unchanged the previous three months. Increases in the indexes for shelter and airline fares accounted for most of the rise, while the indexes for new vehicles, used cars and trucks, and household furnishings and operations all declined."

"Over the last 12 months, the index for all items less food and energy has risen 0.8 percent. The energy index has risen 3.9 percent over that span with the gasoline index up 7.3 percent but the household energy index down 0.2 percent. The food index has risen 1.5 percent, with the food at home index up 1.7 percent."

Interestingly, even after the big increase in gasoline prices over 12 months, the larger energy index was up only 3.9 percent.  That's how the BLS ended its introduction to the November 2010 Consumer Price Index Summary announcement.  

Figure 1, below, breaks down the changes in the CPI-U for October and November 2010 and the last twelve months by major spending category.  Note the categories with significant changes.  Most gasoline and fuel oil were up, but natural gas was down.  Used cars increased by 6 percent over the year, but new vehicles were down slightly.  Most of the other categories were in line with the overall increase.

Figure 1:  Percent changes in CPI for All Urban Consumers (CPI-U)        
U.S. city Average. (Seasonally adjusted) 
  Oct.
2010
Nov.
2010
12 months ended
Nov. 2010
All items .2 .1 1.1
Food .1 .2 1.5
Food at home 0 .3 1.7
Food away from home (1) .1 .1 1.3
Energy 2.6 .2 3.9
Energy Commodities 4.4 .8 7.7
Gasoline (all types) 4.6 .7 7.3
Fuel oil (1) 4.7 4.2 11.1
Energy services .2 -.7 -1.0
Electricity .4 .9 .3
Utility (piped) gas service -.4 -5.7 -4.8
All items less food and energy .0 .1 .8
Commodities less food and energy commdities -.2 -.1 -.2
New vehicles -.2 -.4 -.4
Used cars and trucks -.9 -.5 6.0
Apparel -.3 .2 -.8
Medical care commodities (1) .1 .2 2.7
Service less energy services .1 .2 1.1
Shelter .1 .1 .2
Transportation services .3 .5 2.9
Medical care services .2 .1 3.4
(1) Not seasonally adjusted


[Teacher Note: This is an opportunity to have students look at the price level changes for different product groups and suggest why those prices have changed more or less than the average?  Have political, economic or natural events impacted some prices more than others?] 

[Teacher Note: Ask your students if they think the reported CPI-U or the "core" rate" is a more meaningful measurement of inflation?]

Selected Consumer Price Index Data for November 2010

Food

"The food index rose 0.1 percent in November, the same increase as in October. The index for food away from home increased 0.2 percent while the food at home index was unchanged. Among the food at home groups, the dairy and related products index declined 0.7 percent in November after rising 1.0 percent in October, and the index for other food at home also declined in November following an October increase."

"Over the past year, the food index has declined 0.7 percent. The food at home index has fallen 2.9 percent over the last 12 months, with five of the six grocery store food groups declining, but the index for food away from home has risen 2.1 percent."

For detail about food prices in November, 2010, go to: www.bls.gov/cpi/cpid1011.pdf.

Energy

"The energy index rose 4.1 percent in November after increasing 1.5 percent in October. The index for energy commodities rose 6.3 percent, with the gasoline index increasing 6.4 percent. (Before seasonal adjustment, gasoline prices rose 4.1 percent in November.) The rise in the gasoline index accounted for over three-quarters of the total energy increase.

For more detials about enegy prices go to: www.bls.gov/cpi/cpid1011.pdf.

All items less food and energy

"The index for all items less food and energy was unchanged in November after rising 0.2 percent in October. The heavily weighted index for shelter, unchanged in October, declined 0.2 percent in November.

For more details about the index for all items ess food and energy, go tp: www.bls.gov/cpi/cpid1011.pdf.

Not seasonally adjusted CPI measures

"The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.1 percent over the last 12 months to an index level of 218.803 (1982-84=100). For the month, the index was unchanged prior to seasonal adjustment."

"The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) increased 2.3 percent over the last 12 months to an index level of 212.003 (1982-84=100). For the month, the index increased 0.2 percent prior to seasonal adjustment."

"The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) increased 1.6 percent over the last 12 months. For the month, the index was unchanged on a not seasonally adjusted basis. Please note that the indexes for the post-2007 period are subject to revision."

The Weighted Index

Figure 2, below, shows the weights of the major categories of items making up the CPI-U.  Note how some categories (energy and other*) have changed greatly in price level since the base period of 1982-84.  Other categories (apparel and recreation) have changed very little in their price level.  The CPI-U for all items has increased from the base period when it was 100 by 118.803 percent.

Figure 2:  Consumer Price Index (CPI-U) Weights and Index Levels by Category (November 2010)

 Spending Category

 Weight*

  Index Level

 Food and beverage

 14.8%

  220.991

 Housing

 42.0%

  215.830

 Apparel

   3.7%

  121.498

 Transportation

 16.7%

  195.659

 Medical Care

   6.5%

  391.660

 Recreation

   6.4%

  112.839

 Education/Communication

   6.4%

  130.894

 Other

   3.5%

  383.633

 All Items

  100%

  218.803

 * Weights established as of December 2009

* The "other" category includes items such as tobacco products, personal care products and services, and other personal services.

[NOTE:  Do your students think these categories make sense?  What products do they suggest should be part of the CPI "market basket"?]
 

Connections to Other Macroeconomic Data

It is sometimes instructive to find relationships between various macroeconomic data.  These relationships may sometimes give us a more broad picture of the economy. For instance, there is a general relationship between output (GDP) and employment. As GDP increases, employment tends to increase.  In the past several months, as real GDP has decreased, the unemployment rate has increased. One piece of data confirms the meaning of the other.

Figure 3 illustrates four sets of macroeconomic data - CPI, unemployment, real GDP growth and the federal funds rate. Notice the long term relationship of periods of output growth and decline with the changes in the unemployment rate. This relationship makes sense as the number of employed is directly related to output. Some increase in output can be attributed to improvements in productivity, but growth is very much dependent on labor force growth and employment. In late 2008 and 2009, as U.S. real GDP declined, the unemployment rate increased substantially.

Figure 3:  Selected Macroeconomic Data, 1999-2010

Year Real GDP
Change
(annual)
Unemployment
Rate
(annual)
CPI-U
(annual)
Fed Funds
Rate Target
(November)
1999 4.8 4.2 2.2 4.75
2000 4.1 4.0 3.4 6.00
2001 1.1 4.3 2.8 5.00
2002 1.8 5.7 1.6 1.75
2003 2.5 5.9 2.3 1.00
2004 3.6 5.8 2.7 1.00
2005 3.1 5.2 3.4 2.75
2006 2.7 4.7 3.2 4.75
2007 1.9 4.4 2.8 5.25
2008 0.0 5.8 3.8 2.25
2009 -2.6 9.3 -0.4 0 to .25
2010 2.6* 9.7** 2.1*** 0 to .25

*Real GDP change data for 2010 is through the 3rd quarter.

**Unemployment is the monthly average through November.

***Annual CPI-U estimate is for the first six months of 2010.


Business Cycles

Business cycles or periodic fluctuations in growth and employment illustrate the relationships of some data (see Figure 3). When the National Bureau of Economic Research (NBER) tracks cycles in order to identify recessions, they use the combination of employment, GDP growth and other factors. How do consumer prices fit into this analysis? The NBER uses real GDP growth and real personal income as primary factors identifying business cycles. Using employment and income data adjusted for inflation allows the NBER to make more accurate comparisons from one data period to the next.

[Teacher Note: This is a good opportunity to use the business cycle to illustrate the growth pattern of the U.S. economy over the past couple of years - expansion, peak, contraction, and trough.  Are we still in the trough?]

Inflation and GDP

Accurate measurement of gross domestic product or GDP growth is also dependent on the accurate measurement of inflation. A rise in the price level "inflates" the measurement of GDP growth - miscalculating real growth in the economy. A more meaningful measurement of the growth of output is real GDP - the nominal GDP measurement adjusted for the impact of inflation.  Although CPI is the most common measurement of inflation for many uses, the adjustment of GDP uses a process based on the GDP deflator. Both the CPI and the GDP deflator are measurements of average prices, but the GDP deflator includes all of the goods and services produced in the economy, not just the CPI market basket.

The GDP is the market value of all goods and services produced in a year. Real GDP is the market value of those goods at a constant price level.  Measuring the nation's output in a year at a constant price level means that you can accurately compare it to the output in another year.

CPI vs. GDP Deflator as Measures of Inflation

The rate of inflation rate determined by the CPI and GDP deflator are normally quite similar.  Since the CPI uses a fixed market basked of goods and services, it assumes a fairly constant pattern of consumer purchases. Over time, the market basket may be changed, based on changes in consumer behavior. The GDP deflator uses a flexible basket of goods and services based on the actual quantities of goods and services produced in a year, while the prices of the goods and services are fixed. The GDP deflator uses a much larger quantity of goods and services.

The CPI does not take into account substitution - the tendency of consumers to choose lower priced goods in place of more expensive ones. Just the opposite sometimes happens, as consumers may choose to purchase more expensive goods as their incomes increase. The GDP deflator can take these substitutions into account.  Because the GDP deflator assumes substitutions, it may underestimate the impact of inflation when consumers do not (are not able to) substitute. The CPI may overestimate the impact of inflation when consumers do substitute.

Most government agencies and many private contracts use the CPI to determine a cost of living adjustments (COLA).  The Social Security Administration added a 5.8 percent COLA to Social Security benefits and SSI payments in January 2009, based on  the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of 2007 to the third quarter of 2008.  If there had been no increase in the CPI in that time period, there would have been no increase in benefits.

Inflation and Unemployment

Long-standing economic theory had assumed that there is a predictable trade-off between the impact of public policy decisions and economic change on inflation and unemployment. This theory, developed by New Zealand Economist William Phillips in 1958, was based on his observation of an inverse relationship between money wage changes (inflation) and unemployment in the British economy over a period of time. The "Phillips Curve" proposed that when unemployment is low, inflation tends to be high and when unemployment is high, inflation tends to be low.

The implication for policy makers was that "Keynesian" policies could be used to control unemployment and inflation. Increased spending can lower unemployment with the risk of a high rate of inflation.  Policy makers face the Phillips Curve trade-off. Today, policy makers who propose to use monetary policy (lower interest rates) or fiscal policy (deficit spending) to stimulate the economy, and increase GDP and employment, are aware of its potential inflationary effect. The Phillips Cure theory lost favor in the late 1980s when there were periods of both high unemployment and high inflation, followed in the 1990s by periods of low unemployment and low inflation.

The Federal Reserve recognized this potential trade-off in its most recent monetary policy statement when it justified an aggressive stimulatory policy by saying that the current conditions did not include an inflationary threat. Low inflation provides room for aggressive policies to stimulate the economy. Should inflation become a real threat, the Fed may slow down growth of the money supply.

[Teacher Note:  Ask: Does the Phillips Curve make sense?  Does it apply in this recessionary period?]

ASSESSMENT ACTIVITY


Essay Question:

1. How important is it to adjust economic growth or income data for the effect of inflation?

[Adjusting for inflation allows for a more accurate comparison of one period to another.  Using the CPI to determine real income growth gives a more accurate picture of purchasing power over time.  Using the deflator to determine real GDP growth gives a better picture of actual output, not just the value that can be inflated by the price level change. "Real" data provide a consistent base for comparisons and measurement of "real" growth or purchasing power.]

CONCLUSION

The BLS reported that the seasonally adjusted Consumer Price Index for All Urban Consumers (CPI-U) rose just 0.1 percent in November and rose by just 1.1 percent over the past 12 months before seasonal adjustment.

Far from the fears of deflation that were heard in the depth of the recession (Q4 2008 and Q1 2009), the modest increases in the CPI in 2009 and 2010 indicate that there has been little pressure on prices to increase, but not a deceasing price level (deflation).

Some economic growth and increased demand for commodities and consumer products has stabilized prices at a rate of increase that is lower than many economists see as "normal." The generally accepted theory is that a modest rate of increases in the price level is good for and economy and a natural result of growth.

In the United States, the Federal Reserve System (the central bank) is charged by law with controlling the money supply and other actions to maintain a stable price level and, under normal circumstances, to accommodate a slight rise in prices to encourage growth.  At this time, the Fed has kept the federal funds rate, its primary tool, at a historically low level, zero to .25 percent, to keep interest rates low and encourage borrowing.

EXTENSION ACTIVITY

The BLS tracks a variety of international data, including prices. Take a look at some of the international data.

Go to, "Consumer Price Indexes in Nine Countries, Percent Change From Same Period of Previous Year, 1995-2010."  Read the inflation data about the nine industrialized nations.

  • Do you see any patterns?
  • Which nations have had higher inflation rates than the U.S.? Lower rates?
  • What do you think may account for the differences?

Go to, "U.S. Import and Export Price Indexes, March 2009 ."  Read about the price changes for U.S. imports and exports.

  • How much have import and export prices changed compared to U.S. domestic prices?
  • What imported goods have had the greatest price increases recently? Exports?
  • Which nations' goods have increased in prices the most? Least?