South-Western College Publishing - Economics  
Consumers Spend, Prices Rise
Subject Measuring Spending and Inflation
Topic Employment, Unemployment, and Inflation
Key Words

Inflation, Core Price Index, and National Income and Product Accounts

News Story

Economists use national income accounting to measure U.S. economic performance during specific time periods. Personal consumption expenditures is considered one of the most important variables to determine national income. Personal consumption expenditures includes all durable consumer goods, nondurable consumer goods, and consumer spending on services. With consumer spending making up about two-thirds of all spending in the economy, this variable is vitally important to the economy; hence, analysts watch these numbers carefully.

According to Commerce Department economists, personal spending increased by 1.0 percent in May, compared to a rise of only 0.2 percent in April. This significant jump indicates a strong economy, but also creates fears of possible inflation. "The numbers show that the U.S. economy is doing very well and [also that] inflationary pressures are slowly building," said Peter Frank, senior foreign exchange strategist at ABN Amro.

In order to keep tabs on potential inflation, economists construct measures of inflation in the form of various price indexes. A price index measures the price of a specific "market basket" of goods and services compared to the same basket of goods and services in a base (reference) year. This measure allows economists to determine price change in prices over time. The most common and well- known index is the consumer price index (CPI), which includes a variety of goods and services in its calculation.

Economists also use another index, the core index, which removes food and energy costs from the consumer price index because of food and energy prices can be quite volatile. Fed chairman Alan Greenspan favors this index for spotting inflationary trends, because the core index includes everything except food and energy-two of the most likely sources of inflationary prices. By comparing the CPI with the core index, economists can see where spending increases originate-in additional consumer goods or in increases in prices of necessities.

The consumer price index climbed by 0.5 percent in May, following a revised 0.2 percent in April. At the same time, the core index rose by only 0.2 percent in May and also rose by 0.2 percent in April. This indicates that most of the increase in May could be accounted for by food and energy price increases. "That (core price change) suggests that there is still very modest inflation, which is a good sign for the economy," said Gary Thayer, chief economist at A.G. Edwards & Sons.

This inflationary trend, however modest, will most likely cement the expected increase in interest rates by the Federal Reserve in an attempt to slow inflationary trends.

(Updated August, 2004)

Questions
1.

Give at least three examples of spending for all three categories of consumer spending. (Durable consumer goods, nondurable consumer goods, and services.)

2. Use your textbook to find and explain yet another type of price index besides the CPI and core indexes.
3. Use the Internet to find the most recent measure of the consumer price index as a measure of inflation.
Source Reuters, "May Consumer spending Surges, Prices Up", The New York Times Online, June 28, 2004.

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