You have seen a business cycle before, and we know that it is common for the economy to go through periods of growth and contraction.
Along this business cycle, most people are generally concerned about things like the unemployment rate and inflation--two of the most common concerns for consumers.
In this tutorial, we will focus on inflation.
The Bureau of Labor Statistics, or BLS, measures the rate of inflation in our economy. Inflation refers to an increase in the overall price level.
This happens when many prices increase at the same time. Note, this is not just the price of gas going up or down this week; it is an increase in the overall price level.
Inflation is measured from two different perspectives:
The CPI is the consumer price index, and this reflects a changing price for a fixed bucket of goods and services.
Economists use these price indexes, or measurements, that show how the average price of a standard group of goods changes over time. The most common one is the CPI.
So, it would be impossible to literally measure, in a timely manner, the price of absolutely everything in the economy. Therefore, CPI uses a bundle of goods to represent the "market basket" purchased monthly by the typical urban consumer.
Here is an example of some of the categories in this market basket.
|Food and drinks||Cereals, coffee, chicken, milk, restaurant meals|
|Housing||Rent, homeowners' costs, fuel oil|
|Apparel and upkeep||Men's shirts, women's dresses, jewelry|
|Transportation||Airfares, new and used cars, gasoline, auto insurance|
|Medical care||Prescription medicines, eye care, physicians' services|
|Entertainment||Newspapers, toys, musical instruments|
|Education and communication||Tuition, postage, telephone services, computers|
|Other goods and services||Haircuts, cosmetics, bank fees|
The goods and quantity consumed in this basket are held constant from one period to another.
The prices, though, are allowed to vary, and we use prices that are currently seen in the market, known as nominal prices.
The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in December on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.5 percent before seasonal adjustment.
The PPI is the producer price index, which reflects price movement for raw materials, intermediate, and final good production. So, this is from the producer's perspective.
The idea behind measuring the PPI is to see if there is one stage of the production process that is the cause for price changes in the market.
Therefore the PPI measures wholesale price changes in three different categories:
|Crude goods||The initial inputs in the production process of a good|
|Intermediate goods||Components used to make the end product|
|Finished goods||Goods that are produced and ready to be distributed/sold|
The Producer Price Index for finished goods advanced 0.4 percent in December...At the earlier stages of processing, prices received by producers of intermediate goods rose 0.6 percent in December, and the crude goods index climbed 2.4 percent.
CPI and PPI are both are used to measure price changes or inflation, just from different perspectives.
As mentioned, CPI is from the consumers' perspective, and PPI is from that of the producers. We can calculate the inflation rate with either one, but let's use the CPI here.
To calculate the inflation rate from one period to the next, we use the CPI or PPI in two different periods. Here, we do not list actual years; we simply number each year.
So, CPI2 minus CPI1 divided by CPI1 will give us a rate of inflation.
This shows that there was 3% inflation from CPI1 to CPI2.
- (103 - 100) / 100 = .03, or 3% inflation
The CPI and PPI are used as economic indicators in our economy.
Keep in mind that the PPI generally predicts what is going to happen then in the CPI, because it reflects what the producers are experiencing, and they will likely adjust prices accordingly afterwards. Because this is a good predictor of what is going to happen in the CPI, the PPI is used extensively by investors--more so than the CPI.
The CPI is considered a lagging indicator because it takes some time for prices to adjust to economic conditions:
Macroeconomists are concerned with inflation and deflation, so they closely monitor both of these indicators.
Source: Adapted from Sophia instructor Kate Eskra.