Gas Prices are..What?? Causes & Consequences of Inflation in the US (2022)

This activity is designed for principles courses. Students are expected to have covered supply & demand and have had an introduction to the aggregate demand & supply model. Students should have a basic familiarity with terms: government debt, unemployment rate, inflation, real & nominal GDP, and minimum wage. These terms can be discussed briefly during the exercise as needed.

There are no class size limitations.

This activity has two parts. The first part takes an estimated 15 minutes, and the second part takes an estimated 20 minutes. This activity should take just one class period.

Overview

In this activity, students will reflect on the relatively high inflation in the US in 2022.

First, students will identify groups of people in society that are "most harmed" by unexpected inflation in the US context. Next, students will take the role of an analyst to consider what data they would need to best understand the problem of unexpected high inflation in the US.

Expected Student Learning Outcomes

Students will be able to identify factors that cause inflation.

Students will be able to identify various groups in society that are disproportionately affected by unexpected high or low inflation.

Information Given to Students

Background: The CPI, a measure of inflation experienced by consumers in the US hit 9.1% from June 2021 to June 2022, the largest increase in 40 years. Gas prices nationally hit a high of $5.01 in June of 2022, up from an average of $3.18 in 2021.* For many, this rapid rise in gas prices and in average prices generally was unexpected.

Part 1:
Which person is MOST harmed by unexpected high inflation in the US?

A) A person working at a state's minimum wage that is adjusted once per year to the inflation rate.

B) The CEO of a large bank.

C) A retired elderly couple who lives on their savings which are not adjusted to the inflation rate

D) A public school teacher who has a "cost of living adjustment" automatically included in their wage.

E) A worker at a small bakery who renegotiates their wage twice per year.

Part 2:
Imagine you work for an investment firm and are asked to write a report to identify factors that could cause future inflation. From the list below, which of these data would be most helpful to know for your report?

A) The amount of borrowing and debt by the US government.

B) The minimum wage rates and other price controls put in place by the government.

C) The rate of the increase or decrease in the money supply in the US economy.

D) The US real GDP.

E) The unemployment rate of the US.

Prefatory remarks:
Hook/teaser question: How many of you remember what happened to gasoline prices in 2022? How about food prices at the grocery store?
Transition: We know inflation means a rise in prices on average in the economy, but do you think everyone is affected the same by unexpectedly high inflation?

Justification of answer responses (Part 1):
A) A person working minimum wage likely uses a great proportion of disposable income toward consumption, so unexpectedly high inflation disproportionately impacts lower-income households.

B) The CEO of a large bank might be assumed to be wealthier, so higher prices may not impact this person as much as someone who is poor. This CEO likely also has access to information/resources to shield themself from rising inflation. The bank itself likely will be harmed, especially if it has a lot of loans denominated in fixed nominal interest rates, since lenders are harmed by unexpected high inflation.

C) This is an important group in society: retirees, and since their savings will be eroded by unexpected high inflation, they might be in the worst position.

D) This worker is completely shielded from unexpected inflation, since the wage automatically adjusts.

E) This option is between the minimum wage worker and the manager, and can provide some discussion on the diversity of groups of workers in an economy that are affected at different intensities by unexpected inflation.

The most defensible answer is (C), and (A) is also quite defensible. One could argue that (B) may lose the most money in absolute terms (depending on how hard-hit the bank is), though I don't imagine many would be too worried about (B)'s well-being. (E) will be negatively impacted, but not as much as (A) and (C), and the timing of wage renegotiation is a key difference among the selections. (D) provides an option to consider why "COLA" or cost of living adjustment can be an important stipulation in salaries, and/or a discussion on the role of unions.

Some possible follow-up questions for "Part 1":
If inflation is unexpectedly low instead of unexpectedly high, is the "most harmed" now the "least harmed"?
Can you think of any groups in society that benefit from unexpected inflation (either high or low)?
Should policymakers help to mitigate the harm to some groups during times of unexpected inflation?
What would be a good target inflation rate?
(This can lead to a discussion of why ~2% is the rough target for the US economy.)

Justification of answer responses (Part 2):
Overall notes: For each response, the magnitude of change in data matters (e.g. raising minimum wage 10% or 200% will have proportionate impacts).

A) Borrowing/debt by a government may lead to an increase in aggregate demand (depending on how it is spent), putting upward pressure on inflation.
B) Binding price controls can lead to DWL and exacerbate rising prices through misallocation of resources (persistent surpluses of labor in the case of minimum wage raises and persistent shortages in the case of price ceilings).
C) Increases in the money supply can lead to increases in the AD, putting upward pressure on inflation (assuming velocity constant).
D) rGDP tracks real output and gives information for the supply-side of the economy.
E) Though the unemployment rate gives some information regarding the state of the economy, it is a secondary choice to the others above. Perhaps the concept of the Phillips Curve (theoretical trade-off between inflation and unemployment) could be briefly discussed here, but the unemployment rate is better used as an indicator along with more data to give a better understanding of what is causing inflation.

Answers (A), (C), and (D) are all defensible. Answer (B) can be related, but can help address a misconception that minimum wage raises in the US have a significant impact on inflation.

Some possible follow-up questions for "Part 2":
What might an analyst be looking for in each of those data options that may indicate rising/falling inflation?
What specific reasons do you think caused inflation in the US in 2022?
(multi-factor: Demand-side: low interest rates & federal stimulus from 2020 to 2022. Supply-side: lock-downs in China/Taiwan & disruption with trade, Ukraine-Russia war & fuel prices)

Sources:
CPI: https://www.bls.gov/news.release/archives/cpi_07132022.htm
Gas prices: https://gasprices.aaa.com/

An essay exam question:
Assume you were given the following data for the year 2022 for a specific country: "Government debt rises 20%, government spending increases 18% over the previous year, real GDP increases by 1%, the money supply increases by 13%, and the unemployment rate decreases from 6% to 5%."
What conclusions might you draw (if any) regarding inflation in the year 2022 for that specific country? Does inflation look to be increasing, decreasing, or remaining roughly constant? Explain each piece of data and its relationship to inflation in your explanation.

Two multiple choice exam questions:

1)If inflation is higher than expected, which of the two groups below is better off than the other?
A) A mortgage company with many 30-year mortgage loans at a fixed interest rate.
B) A homeowner with a 30-year fixed mortgage interest rate.
C) Both groups are equally worse off or equally well off.
Answer (B) is correct

2) Which of the following would contribute to higher than expected inflation?
A) A cultural movement of "work less, spend less" has people leaving the labor force and buying proportionately less than before.
B) Consumers have strong positive expectations for the future and begin to use more of their savings for consumption purposes in the short run.
C) The federal government increases income tax rates.
D) New technological innovations increase real production across the technology and medical sectors of the economy, increasing productivity and production.
Answer (B) is correct

The sources below tie to answer responses in "Part 2":

* Federal Government Debt: https://fred.stlouisfed.org/series/GFDEBTN
* Minimum wages by state: https://www.dol.gov/agencies/whd/minimum-wage/state
* M2: https://fred.stlouisfed.org/series/M2SL
* rGDP: https://fred.stlouisfed.org/series/GDPC1
* Unemployment rate data: https://www.bls.gov/cps/