Cost of living is the cost of maintaining a certain standard of living. A cost-of-living index is a price index that measures relative cost of living over time. Such indexes are constructed to have a value of 100 in a given year (or period or place), called the base. An index value of 110 means that the current cost of living is ten percent higher than in the base year. Because the index provides measure of the change in the cost of living, it has no units.
There are many different methodologies that have been developed to calculate cost-of-living indexes, including methods that allow for substitution among items as relative prices change.
- There exist cost-of-living comparison calculators, which compare the cost of living at different locations (such as cities) rather than in different years. A value of 100 for the index would indicate a place with equal overall costs as the base location. A value of 200 would indicate a place where the overall cost of living is double that of the base location.
- A Konus index is a type of cost-of-living index that uses an expenditure function such as one used in assessing expected compensating variation. The expected indirect utility is equated in both periods. This method can be used to introduce risk aversion into cost-of-living indexes.
- The United States Consumer Price Index [CPI] is a price index that is often referred to as a cost-of-living index. The two are related but not exactly interchangeable, however. The US Department of Labor’s Bureau of Labor Statistics [BLS] explains the difference
The CPI frequently is called a cost-of-living index, but it differs in important ways from a complete cost-of-living measure. BLS has for some time used a cost-of-living framework in making practical decisions about questions that arise in constructing the CPI. A cost-of-living index is a conceptual measurement goal, however, not a straightforward alternative to the CPI. A cost-of-living index would measure changes over time in the amount that consumers need to spend to reach a certain utility level or standard of living. Both the CPI and a cost-of-living index would reflect changes in the prices of goods and services, such as food and clothing that are directly purchased in the marketplace; but a complete cost-of-living index would go beyond this to also take into account changes in other governmental or environmental factors that affect consumers’ well being. It is very difficult to determine the proper treatment of public goods, such as safety and education, and other broad concerns, such as health, water quality, and crime that would constitute a complete cost-of-living framework
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