Newsminute Economics: #6 Part 1 The CPI, Plush Animals & Inflation

Hello there, Professor Tigger here. Some numbers for March in the U.S. have got announced. It’s not the lottery numbers. A hint: It’s related to economics! Yes, that number is the Consumer Price Index, which is more important than you think. I’m sure you want to know what all that is about. So let’s dive right in!

The Consumer Price Index, commonly known as the CPI, is used by economists to measure another number, the inflation rate. For March 2022, the CPI number for the United States was 287.504, reaching a 40-year-high as consumer prices rose 8.5% from last year. So how do we measure this number, and who calculates it? What are the advantages and disadvantages of CPI?

In theory, if you had the formula and numbers, anyone could calculate a CPI. However, the numbers used in this episode are the official statistics announced by the U.S. Bureau of Labor Statistics. But no matter who calculates this number, the general formula is the same: The value in the current market basket divided(/) by the value of the current market basket of the base year times(*) 100. In this “market basket” are things that get chosen to represent an entire industry. For example, pork represents the meat industry, and other commodities represent the remaining industries. The “base year” is our chosen year, which could be the current year.

One benefit of this system is that it’s handy for measuring inflation, which is good because inflation could sometimes get out of hand. But the CPI also has disadvantages. I should note that the CPI is not always that accurate. The older generations’ memory contains another inflation indicator: Prices seem to be rising. Why is that happening? There are three chief reasons for inflation. Number one is cost-push inflation. It starts when companies get higher operating costs, potentially due to more expensive raw materials or some other problem like a more expensive land rental fee. That means that companies and producers would need to raise their prices to keep a steady revenue flowing.

The second one is known as demand inflation, when, for some reason, demand for certain products gets high, fast, and the suppliers can’t keep up. When this mismatch happens, the suppliers naturally need to raise the price to compensate for the lack of supply. A cause of demand inflation is people are getting richer, with more money to spend, a nice thing if you ask me. That could be due to tax breaks (by the government), where people have more disposable income. However, if more money gets injected into the economy and contributed to the people, who only want the same things as before, it would contribute to rising prices, thereby causing a negation of the initial benefits of tax breaks. You can see that by issuing tax breaks, governments could cause inflation.

The last reason for inflation, also caused by the government, is printing more money. When there is much, much more money in circulation, then it means that the value of one single bill gets lowered. It’s still the same one dollar (or whatever currency it is), but it doesn’t have the same purchasing power as before. For example, my 10 dollars could buy two bottles of water. With inflation added, I could only buy one bottle. It’s still ten dollars, but because more ten-dollar bills are circulating and not enough water bottles, the amount each of the ten dollars could buy gets lowered. Of course, this is a simplified example. The government doesn’t just print ten-dollar bills, and the people don’t only buy bottles and bottles of water, but you get the idea.

So why would the government print that much money (or issue tax breaks)? If it was on purpose, the likely reason was to cause just a bit of inflation, which is good for the economy, at least in the short run. Let’s picture an economy with only three people, a carpenter, a tailor, and a baker. Suppose that they trade among themselves. Then, the government suddenly prints more dollar bills, and people rush into their stores with the new cash. The three people are delighted and want to satisfy these new customers by working longer hours, ultimately creating more output. For a while, both sides are happy. The tailor’s clothes are selling well, the carpenter’s cupboards and the baker’s cakes are too. Everyone thinks the same: With the new cash, they could buy more of the others’ stuff. However, they didn’t anticipate that the price of the others’ products have risen since they would have hired more people and used more raw materials to keep up with the higher demand. In the short term, inflation could cause an increase in output and increase a country’s GDP(Gross Domestic Product), benefiting the economy.

But what happens next is disadvantageous. When the tailor, carpenter, or baker wants to buy from the other two, they discover the others have higher prices than expected (as said before). Then you would have to buy quickly before the prices rose even more. Since you’re buying more frequently, it would only contribute to even higher prices, and everyone loses (in the same context). Due to this, the three producers would start pulling back supply, not working longer hours since they wouldn’t get the benefits they thought they would.

In conclusion, inflation is like pumping air into tires. You could try it several times. However, if you continue doing it, the tire eventually bursts. If you print too much money or issue too many tax breaks, the economy starts acting weirder and weirder. That’s all for now. I’m sure you’re asking: What about the “plush animals” mentioned in the title of this episode? And what are the actual disadvantages of CPI? All that would get included in Part 2, where we’ll be diving into another, more extreme type of inflation and a famous fad that would prove the CPI has some serious holes in its system. That was Newsminute Economics, and I’m Professor Tigger. Thank you for reading. Tune in next time for more crazy economic news and analysis!