How can we adjust student college benefits for the cost of living?

Principles of Macroeconomics course. Prior to the activity students will have studied the construction of price indices such as the CPI. No class size limits. Activity can be completed in twenty minutes.

Overview

Students evaluate a (fictional) college proposal to adjust financial aid based on inflation measured by the CPI. Teams predict whether this proposal will overestimate or underestimate the impact of inflation and justify their prediction. In order to make this prediction students need to understand the construction of price indices and the relevance of different price indices for different cost-of-living adjustments.

Expected Student Learning Outcomes

Students will be able to evaluate the impact of price index choices on policies designed to adjust prices for inflation.

Information Given to Students

Your team is asked to evaluate a college program to adjust student financial aid based on changes in the local cost of living using the Consumer Price Index- U (CPI- U) (see US Bureau of Labor Statistcs for the current annual percent change in the CPI-U for specific geographic areas).

How will this adjustment correct for price increases encountered by students?
A) Underestimate inflation impact by more than 2%
B) Underestimate inflation impact by more than 1% but less than 2%
c) Approximately measure inflation impact
D) Overestimate inflation impact by more than 1% but less than 2%
E) Overestimate inflation impact by more than 2%

• Student groups can be asked to go to the BLS site to find the current percent change in CPI-U for their area, or the instructor can provide this number at the start of the activity.

• Under or over-estimates depend on the consumer expenditure weights for students versus the weights used in the CPI-U. (As an additional activity students can see the weights used in the CPI-U at CPI weights

• Teams may determine that the CPI-U underestimates student inflation because of higher student expenditure on education that has a higher inflation rate.
  
• On the other hand, lower student expenditure of housing and health care would cause the CPI-U to overestimate the impact of inflation for students. In addition, higher student expenditure on electronics and food, low inflation items, may further cause the CPI-U to overestimate the impact of inflation on students.
  
• Answer analysis: All answers are plausible. The goal is for student to use their understanding of weights and different prices changes for different goods and services to predict the overall accuracy of the CPI – U as a measure of inflation. If teams miss one or more of these concepts consider using prompts such as:
  
  • Which goods or services comprise more of a student budget than the typical consumer? (perhaps list the main areas covered in the index)
  • Which goods or services have had the largest past price changes? (again, perhaps list the price indexes for selected items)

Students can evaluate a similar problem such as the appropriate use of the CPI to adjust social security benefits for the elderly. For discussion on this point see: CPI for the elderly