Focus on Economic Data

Consumer Price Index and Inflation, January 19, 2012

The following link is to the student version of this lesson for students to follow online:
http://econedlink.org/1078

Lesson Details
Grades: 9-12
Author: Douglas Haskell
Posted: January 31, 2012

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This lesson focuses on the Consumer Price Index (CPI) and rate of inflation for the month
of December, 2011, reported on January 19, 2012, by the U.S. Bureau of Labor Statistics.
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), Cost-Push Inflation, Deflation, Demand-Pull Inflation,
Inflation, Inflation Risk, Macroeconomic Indicators, Price Level, Price Stability, Real vs.
Nominal

STUDENTS WILL

Identify the current rate and recent changes in the CPI, and rate of inflation in the
United States in December, 2011.

Identify factors that have influenced recent changes in the inflation rate.

Describe how inflation impacts different groups in the economy.

Distinguish between the core rate and the more broad measures of inflation.

Current Key Economic Indicators

as of May 4, 2012
Inflation
On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers rose
0.3 percent in March after rising 0.4 percent in February. The index for all items less food
and energy rose 0.2 percent in March after increasing 0.1 percent in February.
Employment and Unemployment
U.S. onfarm payroll employment rose by 115,000 in April, and the unemployment rate was
little changed at 8.1 percent. Employment increased in professional and business services,
retail trade, and health care, but declined in transportation and warehousing.
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 2.2 percent in the first
quarter of 2012 (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 of
2011, real GDP increased 3.0 percent.
Federal Reserve
To support a stronger economic recovery and to help ensure that inflation, over time, is at
the rate most consistent with its dual mandate, the Committee expects to maintain a highly
accommodative stance for monetary policy. In particular, the Committee decided today to
keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates
that economic conditions--including low rates of resource utilization and a subdued outlook
for inflation over the medium run--are likely to warrant exceptionally low levels for the
federal funds rate at least through late 2014.

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 wage 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 January 19, 2012, BLS press release of data on the consumer
price index for the month of December, 2011.
For the latest updates on U.S. economic indicators, go to:

EconomicIndicators.gov: http://economicindicators.gov/

BLS Economic Indicator: www.bls.gov/bls/newsrels.htm#major

BEA Economic Indicators: www.bea.gov/newsreleases/glance.htm

[NOTE: You can subscribe to receive monthly BLS email news releases. To subscribe, go to
the BLS News Service Subscription Page. www.bls.gov/bls/list.htm ]
[NOTE on the CPI and Inflation "Focus on Economic Data" Lessons: During the second
semester of the 2011-2012 school year (January-May, 2012), EconEdLink will publish five
lessons on "Consumer Price Index and Inflation." During this time period, the Focus on
Economic Data will begin with the "basics" in January and progressively focus on more
complex data, issues, and comparisons. All monthly lessons will include the current data
and significant recent changes.

January: CPI and inflation (deflation) basics: What is the CPI? What is inflation
and deflation? How are they measured? What do they mean?

February: Details and issues about the measurements and meaning of the
measurements of the price level, adding additional concepts. March: Detailed breakdown
of the data by region and other criteria (trends, identifying trends and comparisons of
regions and demographic groups).

March: U.S. regional and global price level and inflation comparisons.
April: The relationships of CPI and inflation data to other economic data, such as
GDP, employment. etc. and the business cycle. End of year price level summary and
potential issues.
May: School year-end review.

RESOURCES

BLS release of CPI data: January 19, 2012, for the month of December, 2011.
http://www.bls.gov/news.release/cpi.nr0.htmEconomic News Release

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/

"The Consumer Price Index.": This article is from the BLS Handbook of Methods,
Chapter 17. It talks in great depth about the CPI.
www.bls.gov/opub/hom/pdf/homch17.pdf

Frequently Asked Questions About the CPI: This site answers FAQ's for those
trying to read CPI releases.
www.bls.gov/cpi/cpifaq.htm

CPI Inflation Calculator: This calculator allows users to compare price changes over
time due to inflation.
data.bls.gov/cgi-bin/cpicalc.pl

EconomicIndicators.gov: This site provides the latest updates on U.S. economic

indicators.
www.economicindicators.gov/

BLS Economic Indicators: This site provides the latest updates on U.S. economic
indicators.
www.bls.gov/bls/newsrels.htm#major/

Whose Buying Habits Does the CPI Reflect?: This page explains that the BLS
measurement of the CPI-U includes all urban consumers, representing about 87 percent of
the total U.S. population.
www.bls.gov/cpi/cpifaq.htm#Question_3

Consumer Price Index for all Urban Consumers: U.S. City Average, by Expenditure
Category and Commodity and Service Group. This table explains the current level of the
CPI-U.
www.bls.gov/news.release/cpi.t01.htm

BLS Feature: Focus on Prices and Spending- What Does the Producer Price Index
Measure? The BLS breaks down the official definition of the Producer Price Index to clear
up common misconceptions about prices, production, and price pass-though within the PPI.
www.bls.gov/opub/focus/volume1_number9/ppi_1_9.htm

BLS, Frequently Asked Questions webpage

Frequently Asked Questions

Key Economic Indicators

as of January 19, 2012
Inflation

On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers was
unchanged in December, as it was in November. The index for all items less food and
energy rose 0.1 percent in December after increasing 0.2 percent in November.
Employment and Unemployment
Nonfarm payroll employment rose by 200,000 in December, and the unemployment rate, at
8.5 percent, continued to trend down. Job gains occurred in transportation and warehousing,
retail trade, manufacturing, health care, and mining.
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 1.8 percent in the third
quarter of 2011 (that is, from the second quarter to the third quarter), according to the
"third" estimate released by the Bureau of Economic Analysis. In the second quarter, real
GDP increased 1.3 percent.
Federal Reserve
The Committee (FOMC) also decided to keep the target range for the federal funds rate at 0
to 1/4 percent and currently anticipates that economic conditions--including low rates of
resource utilization and a subdued outlook for inflation over the medium run--are likely to
warrant exceptionally low levels for the federal funds rate at least through mid-2013

PROCESS
On January 19, 2012, the U.S. Bureau of Labor Statistics (BLS) reported, "On a seasonally
adjusted basis, the Consumer Price Index for All Urban Consumers was unchanged in
December (2011), as it was in November. The index for all items less food and energy rose
0.1 percent in December after increasing 0.2 percent in November."
Thanks to a decrease in energy prices in December, the overall CPI-U did not decrease over
the month of December. Some other prices did increase, but not much. What does it mean
to you?
To better understand this data, it is important to start with a couple of key price level basic
concepts.
[Note: Unless specifically referenced, quoted data is directly from the January 19, 2012,
BLS announcement. http://www.bls.gov/news.release/cpi.nr0.htm]
What is the Consumer Price Index?
The Consumer Price Indexes (CPI), reported by the U.S. Bureau of Labor Statistics, part
of the U.S. Department of Labor, is a monthly measurement of changes in the prices paid

by urban consumers for a representative market basket of goods and services. An increase
in the CPI from one month to another over time may be evidence of "inflation" in the price
level or a reduction in consumers' purchasing power.
The CPI measures changes in prices over time. By selecting an appropriate base year and
setting the index level for that time period at 100, the CPI compares one month's price
index level with the base year or any other time period. The current standard reference base
period is the average of the period from 1982 to 1984.
To see how the CPI works, you can go to the BLS CPI Calculator. The CPI inflation
calculator allows you to calculate the value of current dollars in an earlier period, or to
calculate the current value of dollar amounts from years ago. Consumer Price Indexes often
are used to escalate or adjust payments for rents, wages, alimony, child support and other
obligations that may be affected by changes in the cost of living.
[Teacher Note: Assign the students different time periods to determine the U.S. rates of
inflation over those time periods. They may want to investigate to determine factors that
may have influenced prices during that time period. Was there economic growth or
decline? What was happening in other parts of the world? Was the population growing?
Link: http://data.bls.gov/cgi-bin/cpicalc.pl]
What is Inflation?
Inflation is generally defined as a continual increase in the overall level of prices. It is an
increase in average prices that lasts at least a few months. Often, a one month increase in
prices is referred to as inflation, but a longer-term upward trend of prices is a more accurate
definition. The most widely reported measurement of inflation is the Consumer Price Index
(CPI). For this announcement, the BLS reports the CPI-U - the consumer price index for all
urban consumers.
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. If the
price level of consumer goods and services increases over a period of time, the consumer's
purchasing power decreases (assuming, of course, that the consumer's disposable income
and spending pattern remain the same).
Just the opposite of inflation, deflation is generally defined as a continual decrease in the
overall level of prices. It is a decrease in average prices that lasts at least a few months. If
the price level of consumer goods and services decreases over a period of time, the
consumer's purchasing power increases (assuming, again, that the consumer's disposable
income and spending pattern remain the same.
Discussion Question: Is this definition what you thought inflation was?
[Teacher Note: BLS web page article Frequently Asked Questions About the CPI provides
information for this discussion.]

Who is Included in the Determination of the CPI-U?

The CPI-U refers to all urban consumers. Because the spending patterns of rural, farm and
some other groups are not consistent with typical "urban" consumers, the BLS restricts the
measurement of the price indexes to urban consumers (CPI-U) or urban wage earners (CPIW).
The BLS FAQ webpage explains: "The CPI reflects spending patterns for each of two
population groups: all urban consumers and urban wage earners and clerical workers. The
all urban consumer group represents about 87 percent of the total U.S. population. It is
based on the expenditures of almost all residents of urban or metropolitan areas, including
professionals, the self-employed, the poor, the unemployed, and retired people, as well as
urban wage earners and clerical workers. Not included in the CPI are the spending
patterns of people living in rural nonmetropolitan areas, farm families, people in the
Armed Forces, and those in institutions, such as prisons and mental hospitals. "Link:
http://www.bls.gov/cpi/cpifaq.htm#Question_3
Bureau of Labor Statistics Announcement
Consumer Price Index and Inflation - December - 2010
Released January 19, 2012
"On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers was
unchanged in December, as it was in November. The index for all items less food and
energy rose 0.1 percent in December after increasing 0.2 percent in November."
"Over the last 12 months, the all items index increased 3.0 percent before seasonal
adjustment. Similar to last month, the energy index declined in December and offset
increases in other indexes. The gasoline index declined for the third month in a row and the
household energy index declined as well. The food index rose in December, with the index
for food at home turning up after declining last month."
A brief explanation of seasonal adjustment from the BLS: 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.
Snow shovel and ice-melt demand will increase in the winter. Bathing suit demand will
increase in the spring and summer. This demand may result in higher seasonal prices.
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 before adjustment for seasonal variation.

Source: BLS, When Should I use Seasonally Adjusted Data?

[Teacher Note: Ask your students to identify goods and services that are affected by
seasonal changes. Their lists may include bathing suits, sun tan lotion, ice cream, winter
coats, ski equipment, lawn care products, school supplies, etc. They should be able to
identify how the demand for some goods and services is impacted be seasonal changes,
such as the weather.]
In the announcement, as usual, the BLS quickly identified energy prices, specifically
gasoline, as a primary factor in the movement of the overall price level. In this case,
influencing the overall level to decline in December.
"Similar to last month, the energy index declined in December and offset increases in other
indexes. The gasoline index declined for the third month in a row and the household energy
index declined as well. The food index rose in December, with the index for food at home
turning up after declining last month."
Because energy and food prices tend to fluctuate more than most other consumer goods and
services prices, the BLS also reports an "index for all items less food and energy." This is
commonly referred to as the "core index" or "core CPI."
"The index for all items less food and energy increased 0.1 percent in December after
rising 0.2 percent in November. The indexes for shelter, recreation, medical care, and
tobacco all posted increases, while the indexes for used cars and trucks, new vehicles, and
apparel all declined."
The BLS also reports the change in the price level over the preceding 12-month period,
both the all items and core indexes. "The all items index has risen 3.0 percent over the last
12 months, a decline from last month's 3.4 percent figure. Recent declines in the energy
index have brought its 12-month change down to 6.6 percent from 19.3 percent in
September. The 12-month change in the index for all items less food and energy held at 2.2
percent, while the 12- month change in the food index edged up from 4.6 percent to 4.7
percent." Again, energy prices were a significant factor in the recent period.
Note: The 12-month index is not seasonally adjusted, because it includes all seasons and
seasonal events.
[Teacher Note: For student discussion, ask: What price changes have you noticed over the
previous few months? Gasoline? Food? Other consumer goods? What about housing or
rent? What was your holiday shopping experience in December 2011?]
What was the Nominal Level of the CPI-U in December 2010?
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 3.0 percent over
the last 12 months to an index level of 225.672 (1982-84=100). For the month, the index
declined 0.2 percent prior to seasonal adjustment. "

CPI-W
The BLS also measures the CPI-W for a more narrow urban population group - wage
earners. The CPI-W is most commonly used for employment contract wage escalations
(often called cost of living increases). "The Consumer Price Index for Urban Wage Earners
and Clerical Workers (CPI-W) increased 3.2 percent over the last 12 months to an index
level of 222.166 (1982-84=100). For the month, the index declined 0.3 percent prior to
seasonal adjustment."
The BLS explains, The Consumer Price Index for Urban Wage Earners and Clerical
Workers (CPI-W) is based on the expenditures of households included in the CPI-U
definition that also meet two requirements: more than one-half of the household's income
must come from clerical or wage occupations, and at least one of the household's earners
must have been employed for at least 37 weeks during the previous 12 months. The CPI-W
population represents about 32 percent of the total U.S. population and is a subset, or part,
of the CPI-U population.
C-CPI-U
The third CPI measurement reported monthly is the C-CPI-U, a "chained" price index.
According to the BLS, the advantage of the C-CPI-U is that it uses a formula that includes
"expenditure data in adjacent time periods in order to reflect the effect of any substitution
that consumers make across item categories in response to changes in relative prices. The
new measure is designed to be a closer approximation to a "cost-of- living" index than the
existing BLS measures." In other words, it more accurately reflects actual consumer
decisions, especially substitution, over shorter time periods.
In December, 2011, the C-CPI-U "increased 2.8 percent over the last 12 months. For the
month, the index declined 0.3 percent on a not seasonally adjusted basis." The C-CPI-U
was designed as a way to adjust for consumer substitution over time periods. When
consumers substitute one product for another, the relative prices may be different. When the
price of a good or service increases (or decreases), consumers may choose to substitute
another good or service.
Substitute: A good or service that may be used in place of another good or service;
examples include tap water for bottled water (or vice versa) and movies for concerts (or
vice versa).
[Teacher Note: Ask your students if they have substituted one good for another because of
an increase in price or the difference in prices. For instance, have they stopped going to
movies or purchasing a particular name brand?]
Typically, a consumer will substitute one good for another good based on their relative
prices. If consumers substitute one good for another good that is part of the market basket,
it is not reflected in the CPI-U. The C-CPI-U is adjusted for these changes.

CPI Example
The level of the CPI-U in December, 2011, was 225.672. That means a market basket of
goods that cost $100 in 1982-1984 (the base year period) now costs about $225.67. That
same basket cost just $219.18 in December of 2010. Over the year, the cost of the market
basket increased by $6.49 - about 3 percent. If your monthly income has increased by about
$6.49 in the past year, your income has kept-up with inflation (at least with the price of this
market basket of goods and services.) Remember, this is a "sample" market basket. If your
spending habits are significantly different from the "average" the impact of inflation on you
is different. If you spent more than the average on energy in August, inflation affected you
more.
[Teacher Note: To review the recent history of the CPI-U from 1990 to the present time, go
to the BLS webpage: http://data.bls.gov/cgi-bin/surveymost ]
Real vs. Nominal Data Measurements
In many cases, data should be adjusted for a change in the price level to make comparisons
over time more meaningful. The term nominal is used to refer to a measurement in current
dollars. To adjust for inflation and determine a real or constant dollar value, the nominal
value is adjusted by the price level change. A measurement such as gross domestic product
in nominal terms refers to the measurement at current dollars (prices.) To compare GDP in
two years, the rate of inflation between the years must be subtracted to determine the real
change.
The same is true for income and purchasing power. Suppose Mr. Jones made $50,000 in
2009 and $52,000 in 2010. His income increased by $2,000 or 4 percent from 2009 to
2010. If the rate of inflation between 2009 and 2010 was 5 percent, Mr. Jones' purchasing
power actually decreased by 1 percent. His 4 percent increase in income did not purchase
the same amount of goods and services as it did in the previous year. Inflation reduced his
purchasing power, even though he had more income.
[Teacher Note: Emphasize the meaning of "real income" or "real GDP" as measurements
of value adjusted for inflation and the importance of adjusting for inflation when making
comparisons over time.]
The CPI Market Basket
The CPI market basket represents all the consumer goods and services purchased by urban
households. Price data are collected for over 180 categories, which BLS has grouped into 8
major groups. These major groups, with examples of categories in each, are as follows:

Food and beverages (ham, eggs, carbonated drinks, coffee, meals and snacks)

Housing (rent of primary residence, fuel oil, bedroom furniture)

Apparel (mens shirts and sweaters, womens dresses, jewelry)

Transportation (new vehicles, gasoline, tires, airline fares)

Medical care (prescription drugs and medical supplies, physicians services,

eyeglasses and eye care, hospital services)

Recreation (television sets, cable TV, pets and pet products, sports equipment,
admissions)

Education and communication (college tuition, postage, telephone services,

computer software and accessories)

Other goods and services (tobacco and smoking products, haircuts and other
personal care services, and funeral expenses)
Figure 1, below, shows the December 2011 price level data for the primary categories in the
CPI-U market basket, including the change from November to December, 2011, and for the
most recent 12-month period.

The CPI is a Weighted Index

Because each product group (energy, food, etc.) represents a different portion of an average
consumer's spending pattern, each category of given a "weight" or what the BLS calls
"relative importance." These weights are based on typical percentages and, in this case,
national averages. Figure 2, below, shows the weights assigned by the BLS to major
product groups.
Weights for individuals may not follow this same pattern. Some people pay a larger portion
of their income for rent or their mortgage than others. A high school student may spend a
much greater portion of his or her income on gasoline, clothes and food than some other
groups. A retired person who has paid-off a mortgage may pay a much smaller portion of
his or her income for housing than other groups.

[Note: The above data are national averages. The category weights differ from region to
region. For instance, when the weight for food and beverage was 15.4 in the Boston region,
it was 16.0 in the Cincinnati region. Food and beverage costs are a slightly larger portion
of the market basket of the index in Cincinnati than in Boston.]
[Teacher Note: It may be interesting for students to determine their own "market basket."
How do they spend their income? What percentages of their income do they spend on
gasoline, clothes, entertainment, etc.?]
Figure 2, below, shows the changes in the monthly CPI-U price level from 2002 through
December, 2011. Note the several periods of higher inflation, the periods of relative
stability, and the not-so-common and shorter periods of declining prices. The key variable
over this time has been the more volatile increases and decreases in energy prices,
especially gasoline.

The Consumer Price IndexWhy the Published Averages Don't Always Match An
Individual's Inflation Experience?
"The Consumer Price Index (CPI) is a measure of the average change in prices paid by
urban consumers for a market basket of goods and services. Because the CPI is a
statistical average, it may not reflect your experience or that of specific families or

individuals, particularly those whose expenditure patterns differ substantially from the
"average" urban consumer." http://www.bls.gov/cpi/cpifact5.htm
Measuring Consumer Prices
There are several measurements or reported levels of the CPI. They are:

CPI: A measure of the average change in prices over time of goods and services
purchased by households.

CPI-U: The Consumer Price Index for All Urban Consumers. This includes
approximately 87 percent of the total population, including wage earners and clerical
worker households, groups such as professional, managerial, and technical workers, the
self-employed, short-term workers, the unemployed, retirees, and others not in the labor
force.

CPI-W: The Consumer Price Index for Urban Wage Earners and Clerical Workers.
This includes households of wage earners and clerical workers, representing approximately
32 percent of the total population.

C-CPI-U: The Chained Consumer Price Index for All Urban Consumers. This
measurement uses a formula that reflects the substitutions consumers make in response to
changes in relative prices.

Core CPI: The average price of the same set of goods and services, without some
of the more volatile components, such as food and energy prices.
How is the CPI 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, $20, and $30. The typical consumer
purchased ten of each good. Total cost of this "market basket" in the base year was $600.
In the current year, the three goods' prices are $11, $24, and $33. Consumers now purchase
12, 8, and 11 of each good. The total current price of this "market basket" is $622, but this
would not be an accurate way to compare the "price level." An accurate comparison has to
assume a constant pattern of purchasing.
The determination of the CPI for the current year uses 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.
Figure 4, below, shows how the change in the CPI was determined for December, 2011.

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.
Causes of Inflation

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.
Demand-pull example: If the economy and the population are growing at a fast pace, food
and energy supplies may not be increasing fast enough. Prices will rise because of the
"pull" of increased demand.
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.
Cost-push example: If OPEC and other oil producers restrict their output, oil prices will
rise. Because oil is an important resource for the production of many consumer goods, the
prices of those goods will rise because of the increased cost of production.
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.
The 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.
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.

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.
The adage "inflation hurts lenders and helps borrowers" really 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.
Inflation reduces the purchasing power of money. If your income is fixed or does not
increase as much as the rate of inflation, you cannot purchase as many goods and services
this year as you could last year. Your real income decreases.
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.
Inflation redistributes income. Those who owe money (borrowers) can repay it with
inflated dollars (if their income increased to keep up with the inflation). Those who are
owed money (lenders) receive dollars with less value when loans are repaid. Hopefully, the
principal and interest received have at least the same purchasing power as the money
loaned. In this situation, income is redistributed from lenders to borrowers.
[NOTE: For additional information on CPI read the article "Measuring the CPI " or take a
look at BLS answers to Frequently Asked Questions About the CPI.]
Other BLS Price Indexes
The Bureau of Labor Statistics publishes several other price indexes which can be used by
consumers, government agencies and, private companies for budgeting and planning.

Producer Price Indexes The Producer Price Indexes (PPIs) are a family of indexes
that measure changes in the selling prices received by domestic producers of goods and
services. They formerly were referred to as Wholesale Price Indexes. When the PPIs are
released, the news media will most often report the percentage change in the index for
Finished Goods. Producer Price Indexes also can be used in escalation contracts. A fact
sheet named Escalation Guide for Contracting Parties further explaining the PPI details is
available.

Import and Export Prices The International Price Program measures change in the
prices of imports and exports of nonmilitary goods between the United States and the rest
of the world.

Employment Cost Trends This program publishes quarterly statistics that measure
change in labor costs (also called employment costs or compensation costs) over time;
quarterly data measuring the level of costs per hour worked are also published. Indexes are
available for total labor costs, and separately for wages and salaries and for benefit costs.
Some information is available by region, major industry group, major occupational group,
and bargaining status.

Contract Escalation Consumer Price Indexes, Producer Price Indexes, and the
Employment Cost Index may be used to escalate contracts.

Consumer Price Indexes (CPIs) Consumer Price Indexes as published by individual

countries, unadjusted for comparability, as well as harmonized indexes for a smaller
selection of countries, are available on the International Labor ComparisonsTables page.
[Teacher Note: Students should be able to identify factors that may influence the prices of
the goods and service they purchase. As a summary discussion (or written assignment),
have them choose a good or service and identify the factors influencing the price over time.
What are the possible demand-pull factors (income or some other change in demand) and
cost-push factors (costs of inputs)?]
[Teacher Note: Student should be able to identify how inflation or a rise in some prices
impacts different demographic groups - teens, families, older adults.]

CONCLUSION
The U.S. Consumer Price Index for All Urban Consumers (CPI-U) did not change in
December, 2011, (seasonally adjusted.) That doesn't mean that prices did not change. Some
prices went up and some prices went down. Most importantly for the determination of the
December CPI-U data, energy prices went down. In December, the seasonally adjusted
"core" cpi (all items less food and energy) increased just 0.1 percent, a slightly slower rate
than the previous month.
December, 2011, is a good example of why it is not meaningful to think about the trend or
"inflation" by looking at just one month's price data. Remember, inflation is a general price
level rise over a period of time. If energy prices rise in January, 2012, the general price
level may rise. Or, it may fall, depending on what happens with other prices.
Keep an eye on energy prices as a part of the more broad CPI-U over the coming months to
determine if the CPI-U or the all items less food and energy (core) price level is the more
meaningful for those who have to carefully plan their spending.

We tend to notice gasoline prices because they are posted in large numbers on street
corners. We watch them move almost every day. We may not notice a price change for
other items because we do not see them every day or purchase those items as often.
[Teacher Note: This may make an interesting class discussion. Students who drive and
spend a much larger portion of their disposable income on gasoline may have a stronger
response to higher gas prices.]
The CPI-U may not be a perfect measurement of the "cost of living" because it does not
take into account individual differences, substitution or qualitative changes over time. It is,
however, a standard measurement we have come to accept as we assess the health and
dynamics of the economy.

ASSESSMENT ACTIVITY

1) The seasonally adjusted CPI-U did not change in December 2011. How does this
compare to the CPI-U change in November 2011?
a) The December CPI-U increase was the same as November [CORRECT]
b) The December CPI-U increase was a smaller than November.
c) The December CPI-U increase was larger than November.
[Consumer Price Index, January 19, 2012, "On a seasonally adjusted basis, the Consumer
Price Index for All Urban Consumers was unchanged in December, as it was in November.]
2) Consumer Price Index, January 19, 2012, "On a seasonally adjusted basis, the Consumer
Price Index for All Urban Consumers was unchanged in December, as it was in November.
a) 225.672 [CORRECT]
b) 219.347
c) 215.183
[The Consumer Price Index for All Urban Consumers (CPI-U) increased 3.0 percent over
the last 12 months to an index level of 225.672 (1982-84=100).]
3) If a family's annual income has increased from $50,000 to $125,000 over the last 25
years (1984 to now), what has happened to the family's real income?
a) Real income has increased [CORRECT]

b) Real income has decreased

c) Real income has remained almost the same
[Over the 25 years, the CPI has increased by just over 110 percent. The familys
income has increased by 150 percent. Using the CPI as a measure to determine the current
purchasing power of the familys income, their real income has increased.]
4) What is the difference between the CPI-U and the 'core' rate of inflation?
a) The core rate includes energy and food prices.
b) The core rate is adjusted for inflation.
c) The core rate excludes energy and food prices. [CORRECT]
[The core rate of inflation excludes energy and food prices, which tend to be more volatile
(increase and decrease more) than other prices. The assumption of the core
rate concept is that the other prices more accurately reflect the general trend of
prices.]
5) Which these spending categories included in the CPI-U had the greatest rate of increase
between November and December 2011?
a) food
b) electricity
c) medical care [CORRECT]
[See the lesson, Figure 2. Food increased 0.2 percent. Electricity increased 0.2 percent.
Medical care increased 0.4 percent.]
6) Which of these groups generally is more hurt the most by unanticipated inflation?
a) Bankers
b) Investment advisors
c) People on fixed incomes [CORRECT]
[Those people with incomes that do not increase with inflation lose purchasing power.
Typically, workers can negotiate pay raises to keep up with inflation but not
always.]
7) If the market basket of goods and services that cost $219 in December 2010 cost $226
December 2011, what was the approximate annual rate of inflation over the year?:
a) 0.3 percent
b) 1.9 percent
c) 3.0 percent [CORRECT]
[The all items index has risen 3.0 percent over the last 12 months, a decline from last
month's 3.4 percent figure. A 3.0 percent increase can be determined from the December

2010 and December 2011 data given in the question]

8) If the economy is nearing full employment and people's incomes are growing rapidly,
what type of inflation is most likely to occur?
a) cost-push inflation
b) hyperinflation
c) demand-pull inflation [CORRECT]
[See the 'Causes of Inflation' section of the lesson. Increases in demand, particularly if
production in the economy is near the full-employment level of real GDP, pull up prices.]
9) Which of these groups generally experiences losses from unanticipated inflation?
a) Lenders [CORRECT]
b) Borrowers
c) Government
d) Businesses
[When borrowers can repay loans with "inflated" money that is not worth as much as it
was prior to the inflation when they borrowed it, they benefit.]

Short Answer Essay Questions:

987-1

1. What is the different between demand-pull and cost-push inflation?

1121

2. Which measurement, the CPI-U or the core rate is the most

meaningful measurement of inflation?

1122

3. Explain how a borrower can actually benefit from inflation?

1123

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1. What is the different between demand-pull and cost-push inflation?

[Demand pull inflation results from increased demand for goods and services. Cost push
inflation results from rising prices for productive resources. If commodity prices force
producers to raise the prices of consumer products, that is an example of 'cost push.' If
population increase and other factors result in a greater number of people wanting a
product, it may be an example of 'demand pull.']
2. Which measurement, the CPI-U or the core rate is the most meaningful measurement of
inflation?
[Those concerned with the prices they currently pay for all goods and services, including
energy and food, may see the CPI-U as more important. These are prices actually paid
from one time to another. Consumers will typically base their spending plans on prices they
currently pay or expect to pay. Inflation creates uncertainty about future purchasing power.
Policy planners may look more at the core rate because energy and food prices have
tended to go up and down over time, even if the longer term trend is upward. Planners
must, necessarily, look at longer trend periods.]
3. Explain how a borrower can actually benefit from inflation?
[Assuming that the borrowers income rises with the inflation, the borrower is repaying a
loan with cheaper dollars. Suppose she earned $10 an hour in year 1 and borrowed $100
for one year at 5 percent interest. In year 2, her income increased to $11 an hour. If she
repaid the loan in year 2 ($100 plus $5 interest), it took her fewer hours to earn the income

to repay the loan. Her income inflated, but her debt did not even with the 5 percent
interest.]

EXTENSION ACTIVITY
Critics of the BLS measurement of the CPI argue that the current measurement process of
the CPI-U has flaws that affect the meaning of the numbers and their impact on consumers.
For instance, the CPU-U measures only urban consumer prices. They say that the CPI-U
does not adequately account for changes in spending patterns over time, substitutions, and
quality changes. Is the CPI-U, as currently measured, meaningful?
Is CPI an accurate assessment of the cost of living? An article in the August, 2008,
"Monthly Labor Review," addresses "Common Misconceptions about the Consumer Price
Index: Questions and Answers " The BLS web page has a summary of the article.
[Teacher Note: Students can read the summary and discuss whether or not the CPI is a
meaningful measurement of cost of living. What are the "pros" and "cons"?]

Text from vid:

The CPI measures the changes in retail prices for goods and
services. In the US, it is considered the number one indicator for
inflation, and it is one of the main economic reports the Fed uses
when determining when to change interest rates.
I'll post a link for the report in the text next to the video.
If you have not done so already, you may want also watch my
video on inflation in the Understanding Economics section.
The consumer price index measures a weighted basket of about
200 commonly purchased goods and services. Each month, the
BLS determines the retail prices for these items and compares
them to the prices from the previous month to gauge the change in
the average cost of living. The data is then grouped into 2 separate
indexes.
CPI (W) category is for for wage earners, and clerical workers.
The CPI (U) is for all Urban workers.
The data most economists pay attention to, the main statistics
reported in the media, and the information used in this video come
from the CPI(U) report.
CPI (W) report for wage earners category, covers about 1/3 of the
working population, and is used for things like cost of living
adjustments in social security payments.
For each category, an index number is provided that is an ongoing,

continuous percent of change in prices from an original start date.

For the main categories, this date is 1982 to 1984. In other words,
every month they compare prices to what the average prices were
in 1982 to 1984, and then add to, or subtract from, the total
percentage of change since then.
So again, they add up the prices in the basket of goods, compare it
to the prices from 1982 to 1984, generate an index number, and
then compare it to the previous index number.
They take the difference between these two numbers, and then
divide it by the previous month index number.
The CPI report is issued monthly about 3 weeks after the month
being reported.
The report contains one main table, A, and several follow up tables.
There are also several short summaries of the data for table A that
contain the most important statistics.
The two main statistics reported in the media are the seasonally
adjusted percent change for the total index from the previous
month, and the non-seasonally adjusted 12 month percent change
of the total index.
The first is the one month total change in prices for goods and
services throughout the country, adjusted for seasonal factors such
as weather conditions. This is the seasonally adjusted inflation rate
for one month.
The second is the total change in prices for goods and services for
an entire year. This change is not adjusted for seasonal factors, so
it more accurately reflects the total change of prices consumers
pay. In other words, this is the total inflation rate for a whole year.
In addition, perhaps equally important, is the seasonally adjusted
rate of change for all items less food and energy. In this section,
items relating to food and energy are removed. Because of the
volatility of prices of items in these two categories, some
economists feel that by removing these items, one gets a more
accurate view of inflation. This category is often referred to as Core
CPI.
As I mentioned before, there are several follow up tables at the end
of the report. The first table is the change of prices for the entire
basket of goods broken down into detail which shows the change of

price for individual sections, sectors and commodities.

The 2nd table is the same thing, only the prices and index numbers
have been seasonally adjusted.
The third table is the change of prices broken down by different
areas.
On table worth mentioning is table 7- the chained consumer price
index. This report attempts to take into account substitutions
consumers make when prices change in the regular CPI basket of
goods....