Does the CPI Measure Household Inflation Accurately? Which Households?

• This activity is appropriate for a principles of macroeconomic course. Prior to its implementation students would have already been introduced to price indices (CPI) and how the CPI is used to measure the inflation rate.
• Before class, students will listen to National Public Radio's The Indicator podcast, "Who Eats the Higher Cost of Food Inflation?"
• The following questions could be assigned along with the podcast to focus and structure what students glean while they listen. Students submit responses BEFORE CLASS online in the LMS for you to see (perhaps not other students) prior to the class to help lead pre/post activity discussion. An effective technique for this sort of pre-class work is "Just in Time Teaching" (see this link) 

1.  What are the three reasons why inflation can disproportionately impact lower income households?
2.  Explain how the CPI would underestimate the impact of inflation on lower income households?
3. Why is this underestimate of inflation for lower-income households problematic for policy and what is a possible solution
4. Which particular products in your life have recently been most impacted by inflation

Overview

Students will listen to NPR's The Indicator podcast Who Eats the Higher Cost of Food Inflation?" It describes how poorer households are disproportionately impacted by inflation because the prices of non-premium brands have been increasing more rapidly than premium ones. The activity will reinforce students' understanding of how inflation is measured by the CPI and how the effectiveness of policy like SNAP benefits relies on accurate measurement.

Expected Student Learning Outcomes

After completion of this activity, students should be able to:

• Explain why the standard CPI measure may not reflect the true cost of inflation for heterogeneous households

Information Given to Students

For this group activity, students receive the following information:

The Food and Nutrition Services (FNS) division of the USDA is responsible for determining the monthly allowances for the Supplemental Nutrition Assistance Plan (SNAP). This partly depends on a households' income level, and this income level is adjusted periodically for inflation.

Say you are an intern working at the FNS. You learn that the prices of food items that lower income households typically purchase is increasing faster than the prices of food items that higher income households typically purchase (similar to the situation described in the podcast). Based on what you know about the Consumer Price Index, what is the best solution to this problem?

A. Increase SNAP benefits so that lower-income families can purchase "premium" goods like organic foods that higher-income families purchase.
B. Since the CPI underrepresents inflation for lower-income families, increase their monthly SNAP benefits by 2% more in order to account for this.
C. Link the value of the "poverty line" to the CPI so that if prices go up, the threshold falls, making more households eligible for assistance.
D. Collect more granular (e.g. brand-level) data to better map out what households buy and include this in the CPI

• Students hear a vivid example that shows how, in reality, our aggregate measure of inflation imperfectly measures price increases faced by certain households. This activity pushes students up Bloom's pyramid from simply "understanding" the CPI to "evaluating" how policy effectiveness hinges on its accuracy.
• The podcast gives a quick explanation of concepts like SNAP benefits and the federal poverty threshold. It may be useful for the instructor to recap or expand on this. Students have often heard about "food stamps" or the "poverty line" or "welfare", but have no idea what even the ballpark numbers are, or how they are calculated.
• Some notes on the available options for students in the exercise above:
  Option A: After listening to the podcast, some may feel that it is "not fair" that lower income families can only afford less healthy foods. In this case, they may gravitate towards this answer. However, this choice does not address the core issue– the current CPI underestimates inflation for poor households. 
  Option B & C: Current SNAP benefits and the federal poverty threshold are in fact, adjusted annually to reflect price changes in the economy (this is mentioned in the podcast and some students may even do some research on their own). So linking the CPI will not remedy the core problem.
  Option D:This would be the true solution to the problem. However, students may argue that collecting and including all the granular data would be too cumbersome. The CPI, despite its flaws, still does an adequate job of capturing prices changes and we should not try to "over complicate" its construction.
• The podcast and exercise may lead to an energetic discussion on access to healthy foods, poverty, government benefits and inequality in general. This is certainly welcome, but students should also not stray too far away from the core idea: recognizing that our macroeconomic indicators are not perfectly constructed, aggregate measures mask much heterogeneity within the economy and ultimately policy effectiveness will be constrained by these issues.

Q1) If consumers purchase fewer of those products that increase most in price and more of those products that decrease (or increase least) in price as compared to the CPI basket, then
a) changes in the CPI accurately reflect the true rate of inflation.
b) changes in the CPI understate the true rate of inflation.
c) changes in the CPI overstate the true rate of inflation.
d) changes in the CPI are unrelated to the true rate of inflation.
Answer: c

Q2) Energy is a large component of the market basket used to create the CPI number each month. This section of the index includes motor fuel or gas. Say, fuel and gas prices have risen dramatically in recent months. Given this, for which household would the CPI more accurately reflect the impact of inflation: a family living in a city or a suburban family? Why?
Answer: The suburban family because they are more likely to be driving and buying gas. 

This question could be changed to ask about the medical expenses category (senior citizen or young adult) or food (single person or large family)

The following website has information on SNAP and the poverty threshold.
https://www.fns.usda.gov/snap/supplemental-nutrition-assistance-program
Further it is illustrative to show actual "numbers" for example, what is the income of a typical, eligible family of four and what are the maximum monthly benefits. See the following website:
https://www.fns.usda.gov/snap/recipient/eligibility
The monthly CPI report and factsheets can be found at: https://www.bls.gov/cpi/
Students may relate better to the CPI when it is deconstructed. That is, when they see specific categories and subcategories that make it up.