# Baskets, Base Years, and Bias: Constructing and Using a Student Price Index

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1 Lesson by Sherilyn Narker, economic and financial education specialist, Federal Reserve Bank of Atlanta Lesson description In this activity, students will simulate how changes in the money supply in their classroom economy affect the price of a market basket of goods auctioned in their classroom. Students will then construct a price index using a simplified basket of teen-friendly goods and services. Using their market basket values, students will calculate a student price index and an inflation rate. Students will prepare a short paper or presentation analyzing the validity of using their Student Price Index as a measure of inflation. Concepts Base year Bonds Consumer Price Index (CPI) Federal Reserve System Fiscal policy Inflation Inflation rate Market basket Monetary policy Money supply Open market operations Substitution bias Unmeasured quality changes Objectives Students will be able to: Define key terms such as market basket, Consumer Price Index, inflation, inflation rate, substitution bias, and unmeasured quality changes Simulate how changes in fiscal policy can affect the price level in the economy Simulate how changes in the money supply can affect the price of a market basket of goods Describe how open market operations cause changes in the money supply Calculate a market basket value, a student price index number, and the inflation rate Contrast two market basket values, determining reasons for differences in value Describe the strengths and weaknesses of using a price index as a measure of inflation in a brief paper or during an oral presentation Related content areas Government/Economics/Business Education Time required (110 minutes) Two regular 55-minute class periods or one class period on block schedule Page 1

4 19. Tell students that this is known as fiscal policy and it is an action that Congress and the president can use to encourage increased consumer spending in the economy. 20. Write Expansionary Fiscal Policy in the Reason for Change column on the chart next to Round Tell the students that they are now going to calculate the percentage by which the price of the bag of candy rose between Round 1 and Round 2. Use the following formula to calculate the change: [(Round 2 Price Round 1 Price) / Round 1 Price] X 100 = Percentage Change in Price. 22. Record the percentage change in the column labeled Percent Change in Price on slide 4, Visual 1 for Round 2. Emphasize that the product remained the same, only the cost of buying it changed. 23. Tell students that an important institution in our country becomes concerned when not enough people buy products relative to how many have been produced. The U.S. Congress has been this institution, called the Federal Reserve System, the authority by to promote price stability and maximum employment. 24. Explain that in the event of a downturn in the economy, known as a recession, the Federal Reserve may encourage increased economic activity by increasing the availability of money and credit in the economy. Explain how this is often done through a policy option called open market operations, which is the buying and selling of government securities, or bonds, by the Federal Reserve. This market activity affects bank reserves, interest rates, and the money supply. Changes in the money supply also affect the currency and demand deposits at financial institutions. 25. Tell students that bonds are certificates of indebtedness that a government or publicly held corporation issues, promising to repay borrowed money at a fixed rate of interest and at a specified date of maturity. 26. Tell students you will now act as the Federal Reserve and buy some bonds from them. This is an example of open market operations. 27. Go around the room and buy all the bonds held by the students for face value. 28. Update the information for Round 3 by filling in the cash held by students. This is the Round 2 amount minus the price of the bag of candy in Round 2 plus the amount of cash distributed when the bonds were purchased from the students. The bond value should now be zero. 29. Hold up another small bag of mixed candies or other small goodies. Make sure this bag is identical to the first bag. Ask the students to bid on the bag. Allow time for the price to rise significantly in the auction and then take a bid. Allow students to combine funds. 30. Record the winning bid on the chart in the column labeled Price of Good next to Round 3 on slide 4, Visual Ask the students why the price rose. They will likely respond that people had more money to spend than in Round 2. Page 4

10 Simulation Item 1: Classroom Currency Page 10

11 Simulation Item 2: Classroom Bonds Page 11

12 Visual 1: Inflation Simulation Chart Round 1. Cash Held by Students Value of Classroom Bonds Price of Good Reason for Change Percent Change in Price Current Round Price Previous Round Price X 100 Previous Round Price Page 12

13 Visual 2: 2012 Consumer Price Index Categories and Weights Education/ Communication 7% Recreation 6% Medical care 7% Other 3% Food/Beverages 15% Transportation 17% Housing 41% Apparel 4% Source: U.S. Bureau of Labor Statistics Page 13

14 Visual 3: Student Calculations Record Sheet Group Name Value of Each Student Market Basket Computed Student Price Index Inflation Rate Page 14

16 Handout 2: Student Market Basket of Goods (page1 of 3) Basket of Goods School Year = Total Value: \$ Good or Service Quantity (per year) Price X Quantity = School supplies Ballpoint pens 2 packs of 10 Graphing calculator 1 Backpack 1 Lined notebook paper 4 packs of 250 sheets Binders 5 Other: School supplies total: Senior "stuff Senior dues 1 Yearbook 1 Prom tickets (per couple) 1 Cap and gown 1 Tuxedo rental 1 Prom dress 1 Other: Senior stuff total: Entertainment Music downloads 10 Movie tickets 12 Tickets to sports games 5 Concert tickets 2 Teen "nightclub" tickets 10 Magazine subscriptions 2 Other: Page 16

17 Handout 2: Student Market Basket of Goods (page 2 of 3) Entertainment total: Food Pizza: large, 1-topping 15 Fast food burritos 20 Fast food hamburgers 20 Fast food roast beef sandwich 20 Ice cream cones 24 Gourmet coffee drinks 24 Other: Food total: Transportation Gasoline: Gallon of unleaded 219 Car insurance (for one year) 1 Other: Transportation total: Communications Cell phone 1 Monthly cell phone service plan 12 Other: Communications total: Clothes Jeans 5 Shirts 15 Sweatshirts 3 Bathing suit 2 Shoes (other than athletic) 2 Page 17

18 Handout 2: Student Market Basket of Goods (page 3 of 3) Athletic shoes 2 Other: Clothes total: Personal care Deodorant 12 Haircuts/hairstyling 8 Toothpaste 5 Chapstick 6 Other: Personal Care Total: Page 18

19 Extension (Visual 4): Student Price Index Categories and Weights Personal Care 13% Education/ Communication 7% Communications 13% School Supplies 12% Senior Stuff 12% Entertainment 12% Transportation 13% Food 12% Page 19

20 The Fed Explains Inflation 1. One negative aspect of inflation for the average consumer is a. Wages and salaries rise b. Interest rates on savings rise c. The purchasing power of income falls d. The prices of assets, such as homes, rise 2. Inflation can best be described as a. An increase in the price of necessities b. An increase in the purchasing power of the dollar c. A rise in the average price level of goods and services d. An increase in the amount of goods and services produced in the economy 3. The cost of living refers to a. The current price level in the economy b. Changes in the price level from one year to the next c. Increases in wages and salaries based on the inflation rate d. The amount of money needed to sustain a particular level of living 4. The Federal Reserve System keeps price level stable by a. Adjusting the number of dollars in circulation. b. Supervising and regulating the banking system. c. Processing electronic payments for commercial banks. d. Recommending changes to taxes and government spending. 5. Which of the following inflationary situations could Federal Reserve monetary policy most directly address? Select all that apply. a. The increases in price level are caused by too many dollars circulating in the economy b. Corn, a major input in food and energy production, suffers a drought forcing price level upwards c. Higher wage demands by workers increase production costs and the price level of goods and services d. Price level rises after sustained increases in the price of oil, a major input into many goods and services in the economy Page 20

21 6. Protecting the purchasing power of the dollar means a. Keeping the price level constant at all times b. Ensuring that increases in price level will be gradual and predictable c. Setting maximum prices for necessities so most people will be able to afford them d. Insuring everyone s bank deposits through the Federal Deposit Insurance Corporation 7. Price level can be defined as a. The percent change in prices from one year to the next. b. The average of the current price of everything sold in our economy c. The market value of goods and services produced in the economy in a given year d. The annual cost of maintaining a particular standard of living within an economy. 8. One major purpose of Federal Reserve monetary policy is to a. Reduce the number of dollars in circulation when price level is rising. b. To adjust marginal tax rates downward when economic activity slows. c. Increase production of necessary goods and services during times of shortage. d. To reduce government spending in the economy when the price level is rising too fast. 9. With which of the following statements would most economists agree? a. Any increase in the inflation rate is bad for the economy b. Increases in prices are always due to inflation in the economy c. Gradual, predictable increases in the inflation rate promotes economic stability d. Increases in the inflation rate are fine as long as they are equal to increases in the GDP growth rate 10. An increase in prices is always due to inflation. a. True b. False Page 21

22 The Fed Explains Inflation Answer Key (A * indicates the correct answer.) 1. One negative aspect of inflation for the average consumer is a. Wages and salaries rise b. Interest rates on savings rise c. The purchasing power of income falls* d. The prices of assets, such as homes, rise 2. Inflation can best be described as a. An increase in the price of necessities b. An increase in the purchasing power of the dollar c. A rise in the average price level of goods and services* d. An increase in the amount of goods and services produced in the economy 3. The cost of living refers to a. The current price level in the economy b. Changes in the price level from one year to the next c. Increases in wages and salaries based on the inflation rate d. The amount of money needed to sustain a particular level of living* 4. The Federal Reserve System keeps price level stable by a. Adjusting the number of dollars in circulation* b. Supervising and regulating the banking system c. Processing electronic payments for commercial banks d. Recommending changes to taxes and government spending 5. Which of the following inflationary situations could Federal Reserve monetary policy most directly address? Select all that apply. a. The increases in price level are caused by too many dollars circulating in the economy* b. Corn, a major input in food and energy production, suffers a drought forcing price level upwards c. Higher wage demands by workers increase production costs and the price level of goods and services d. Price level rises after sustained increases in the price of oil, a major input into many goods and services in the economy 6. Protecting the purchasing power of the dollar means a. Keeping the price level constant at all times b. Ensuring that increases in price level will be gradual and predictable* Page 22

23 c. Setting maximum prices for necessities so most people will be able to afford them d. Insuring everyone s bank deposits through the Federal Deposit insurance Corporation 7. Price level can be defined as a. The percent change in prices from one year to another year b. The average of the current price of everything sold in our economy* c. The market value of goods and services produced in the economy in a given year d. The annual cost of maintaining a particular standard of living within an economy 8. One major purpose of Federal Reserve monetary policy is to a. Reduce the number of dollars in circulation when price level is rising* b. To adjust marginal tax rates downward when economic activity slows c. Increase production of necessary goods and services during times of shortage d. To reduce government spending in the economy when price level is rising too fast 9. With which of the following statements would most economists agree? a. Any increase in the inflation rate is bad for the economy b. Increases in prices are always due to inflation in the economy c. Gradual, predictable increases in the inflation rate promotes economic stability* d. D Increases in the inflation rate are fine as long as they are equal to increases in the GDP growth rate 10. An increase in prices is always due to inflation a. True b. False* Page 23

24 Standards and Benchmarks National Standards for Economic Education Content Standard 19: Unemployment and Inflation a. Students will understand that inflation imposes costs on individuals and the overall economy. b. Students will be able to use this knowledge to make informed decisions by anticipating the consequences of inflation and unemployment. Content Standard 20: Fiscal and Monetary Policy c. Students will understand that federal government budgetary policy and the Federal Reserve System s monetary policy influence the overall levels of employment, output, and prices. d. Students will be able to use this knowledge to anticipate the impact of federal government and Federal Reserve System macroeconomic policy decisions on themselves and others. National Curriculum Standards: Common Core Standards Grades 9-10 students Grades students Integration of Knowledge and Ideas 7. Integrate quantitative or technical analysis (e.g., charts, research data) with qualitative analysis in print or digital text. 7. Integrate and evaluate multiple sources of information presented in diverse formats and media Writing Standards for Literacy in History/Social Studies 6 12 Research to Build and Present Knowledge 7. Conduct short as well as more sustained research projects to answer a question (including a self-generated question) or solve a problem; narrow or broaden the inquiry when appropriate; synthesize multiple sources on the subject, demonstrating understanding of the subject under investigation. 7. Conduct short as well as more sustained research projects to answer a question (including a selfgenerated question) or solve a problem; narrow or broaden the inquiry when appropriate; synthesize multiple sources on the subject, demonstrating understanding of the subject under investigation. Page 24

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