Cost Of Living Index

By Sean Stevenson – Latest Revision February 9th, 2021

Defining The Cost Of Living Index

A cost of living index is a measure of the expenses incurred over time to acquire essential goods and services.  The terms of what may be considered “essential” will differ from region to region, based on standards of living. 

Moreover, some items that may be considered “essential” can be substituted with other items as prices fluctuate. 

Today, there are many methodologies used to gather and analyze data related to approximated costs of living.

For reference, essential economic items being sought by consumers may include:

  • Housing or Shelter.
  • Food and water.
  • Education.
  • Clothing.
  • Reliable transportation.
  • Electricity.
  • Entertainment.
  • And more.

An important function of the cost of living index is that it tracks how much essential-living commodities rise over time.  Economists often use this index to gauge inflation, consumer sentiment, and other market influences.

Interestingly, the U.S government does not officially track the cost of living index themselves.  Rather, there are a multitude of independent organizations who generate meticulous reports in its stead.

It should be noted that the difference in prices for both goods and services can differ vastly from one region to another.  Comparing their cost of living indexes can offer deep insights into why some areas are more expensive than others.  It can also offer important information for those seeking a new location.

Cost Of Living Index

As depicted above, the cost of living index can highlight expensive and inexpensive regions.  HCOL commonly stands for “high cost of living.”  Conversely, LCOL stands for “low cost of living.”  The red and blue “pins” illustrate this difference for us on this particular map.  

Understanding The Cost of Living Index

It is often noted that prices of rural and urban areas can vary greatly.  Everything from the price of good, transportation, and housing, are all considered when the cost of living index is weighed by analysts.

To comprehend the comparative nature of the cost of living index, any individual may ask themselves how far their money will go in one region as opposed to another.  The difference can be staggering.

Example

The market influence that heavily increases the price of real-estate in urban New York, is not the same as in rural Ohio.  In New York, there is huge demand for real-estate.  With such a massive population in such a concentrated area, there is a shortage of supply compared to the outweighing demand.  This drives prices upward.

Conversely, in rural Ohio, there is less of a demand for real-estate property overall.  This means that the price will be substantially lower when compared to the pent-up demands of New York.

Rural Ohio would be considered a low cost of living index in terms of its real-estate affordability. 

Using the same indexed metric (real-estate), New York would be considered a high cost of living index. 

Since its real-estate is priced much higher in comparison to many other regions, New York’s market has a significant barrier to entry that can price many individuals out of the marketThis would mean that consumers with lower incomes would likely have to rent their shelter, rather than seek to own it outright and build personal equity.

All of this -and more- would be considered by the cost of living index.

Impact

Many people view the cost of living index as a way to understand their place in a larger economy. 

An individual may choose higher paying employment, with more difficult job-related tasks, in order to supplement a life in a city.

In more recent times, the cost of living has greatly impacted marriage and birth rates.  People are finding their economic circumstances increasingly difficult to navigate.  With wages have remained stagnant and productivity only going up over time, competition has greatly increased in the general marketplace.

Due to such increases in the cost of living index, the middle-class has suffered greatly.  Many now claim -given their personal economic circumstances- that home ownership, post-secondary education, and even children, are now unaffordable luxuries. 

Naturally, these concerns are gravely distressing, and reveal the prevalence of ever-rising costs associated with living.

How The Cost of Living Index Functions

While there are many different metrics and analysis formats used in discerning the cost of living, the most common is often represented by a base cost of living.  This is often cited at a “baseline” of 100.

The cost of living index can reflect a specific city or an average of several regions all at once.

A key component of understanding the cost of living in a particular area, is to compare its median income levels to the goods and services being offered.  If median income levels are much higher than the price of goods and services, then it is likely that the region enjoys a relatively lower cost of living.

Example

When comparing Seattle to Toronto, a baseline is first established between the two.  If Toronto serves as the “100 baseline,” then we can gauge its relative cost of living index to that of its southern neighbor.

Assuming Seattle is more pricy than Toronto, it will be above the “100 baseline” threshold.  For argument’s sake, we can assume it is 20% more costly on average to live in Seattle.  This would be represented by Seattle’s cost of living index rating of “120,” which is 20% greater than Toronto’s rating of “100.”

Key Takeaways

  • The cost of living index actively compares different regions, cities, and towns.
  • To accomplish its comparison, the cost of living index will often use a baseline of 100.  However, not all organizations or watchdogs will use this same formula.
  • The cost of living index includes everything from food, water, shelter, electricity, healthcare, to electricity.  Anything deemed essential or valuable to everyday life, is likely included in the index.
  • Over time, the cost of living index can reveal just how sharply prices have increased or decreased.  To date, basic expenses have risen considerably, while wages have remained stagnant.

Indexes Today

As noted, there are to date many organizations and indexes which actively track the relative cost of living across the globe.  These can be easily reviewed by anyone seeking additional information.

Below are three examples for your reference, along with their associated use.

The Economic Policy Institute

The Economic Policy Institute (or EPI for short) is a non-profit organization that was founded in 1986.  Their index consists of the associated costs of living in various cities and regions across the US.

In particular, they are concerned with the nonpartisan needs of low and middle-income workers.  They believe everyone has the right to affordable healthcare, along with security in their retirement.

Their website offers several calculators, to both better understand the prices of different regions and to compare these costs categorically.  Moreover, their encyclopedic rendition on the State of Working America, has been published 12 times since 1988.  It is currently available in e-book format, for those enterprising enough to delve into its voluminous and engrossing economic information.

 Social Security Administration’s COLA Index

Cost of living adjustments (otherwise known as “COLA”) are made annually for retirees that are receiving their social security benefits.  These adjustments take into consideration the rate of inflation.

The importance of these adjustments ensures that the paid benefits are not diminished by rising rates of inflation within the economy.  This helps keeps retirees secure by hedging against percentile increases in the cost of living index.

ACCRA COLA

The ACCRA COLA actively compares living expenses throughout the US, with a key focus on:

  • Housing.
  • Utilities.
  • Health care.
  • Transportation.
  • Food.

In 2019, the report clearly demonstrated that New York had the highest-rated cost of living index in the US, with San Francisco trailing closely behind.

Case Study: A Harsh Reality

Market commentators have steadily witnessed an excruciating rise in the cost of living index globally.

Most necessities have steadily increased over time.  In fact, the price of food, energy, healthcare, clothing, and even communication, have all risen greatly in the past few decades.

A study conducted by CNBC.com (1)  on these rising costs, found that “nearly half of Americans say (the) rising cost of living is the greatest threat to financial security.”

Moreover, an average 2% increase in general costs associated with living expenses has become common year over year.

Cost Of Living Index

To illustrate the effect of inflation, the depiction above shows us its cumulative effect over time (based on an average 2% rate of inflation over 6 years).

Consider that the cost of out-of-pocket health care for Americans alone, has more than doubled since 1984.

Housing prices rose over 3.2% in the previous fiscal year also.  Marking another steady increase that further threatens to price many consumers out of the housing market entirely.

Reports such as these can clearly illustrate the intense impact that the cost of living index has on us all.  As prices cumulatively increase across the board, consumers are left with crippling price-hikes on goods and services that they rely upon in their daily lives.

In contrast to these continuously rising costs, realized wages have effectively remained at a standstill for decades.  A record 9% decline since 2006, reveals a deep-rooted fragility that has taken hold within our global economy.  The wealth gap between rich and poor is set to grow ever-wider.

Moreover, given the current pandemic raging across the globe, there is some significant cause for concern as instability and disruption continue to plague efforts towards returning to normalcy.

For the first time in history, we have effectively -and willingly- shut down our entire globalized economy.  The situation remains unprecedented and nobody knows what will come of this.

However, it must be said that it isn’t all “doom and gloom.”  Our globalized economy has brought us many tangible benefits.  Standards of living across the globe are on the rise.

Hence, while there are -and always will be- areas of concern, our economic progress is still headed in the right direction for the most part.

History of the Cost of Living Index

The economic theory for the cost of living index is attributed to one A.A. Konüs, a Russian economist. 

In essence, Konüs postulated that most people are interested in the best deals available to them.  As they spend their money in similar ways on necessities from year to the next, a comparison of fluctuating pricing can be made.

This effectively leads to the cost of living index as we know it today.  It readily exposes the effects of inflation, along with the shifts taking place in our economy.

The essence of the cost of living index boils down to measuring the cost of achieving a certain standard of living in one year relative to the next.  Over time this can offer deep insights into the principle rise or fall of various economical metrics.  An approximation of the trend will often reveal future expectations for the performance of various goods and services as they relate to their associated costs.

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