What, exactly, does “cost of living” mean — and how is it calculated?
What, exactly, does “cost of living” mean — and how is it calculated?
The phrase “cost of living” has been popping up a lot as inflation has boosted prices in the last few years. It’s also top of mind for policymakers — and for employers when they set salaries and benefits.
But there are many ways to measure the cost of living, each with its own set of components.
The Council for Community and Economic Research’s cost of living index, which is licensed to NerdWallet, Bankrate and other websites, includes items like a loaf of bread, a dozen eggs and a 12-inch Pizza Hut pizza. The data can get pretty in the weeds. Take dishwasher detergent: Do you sample the price of powder, liquid or pods?
“If we’re noticing Walmart, Target, Safeway, they all have the 72-count dishwashing pods, you know. That’s what we’re probably going to price,” said Tyler Baines, one of the index’s project managers.
The index includes items that are most popular among households. But to figure that out requires a prototype. In other words, whom are you measuring the cost of living for? In this case, it’s an upper-middle-class consumer whose residence is a four-bedroom, two-bathroom, 2,400-square-foot house. The prices come from a mix of retailer and government data and information reported by volunteers.
“They have to call these hospitals and these local practitioners and ask them, you know, what the price of a standard office visit is,” Baines said.
Health care is a given in most cost of living indexes, of which there are many. The Living Wage Institute calculates the bare minimum it takes to get by in any given area.
“There’s no budget for eating out at a restaurant or leisure time, holidays or unpaid vacation,” said founder Kavya Vaghul. “And it doesn’t account for really important factors for long-term financial security like savings, retirement and investments.”
The living wage index gets updated for inflation every year. And though it began mostly as an advocacy tool, employers increasingly use it to calculate the cost of expanding their business into a new area.
“That benchmark is such a critical first step,” Vaghul said.
These benchmark tools are helpful. But they’re also pretty imperfect. “That’s because there is no theoretically correct way to do this that’s very clean,” said Jonathan Parker, a finance professor at the Massachusetts Institute of Technology. “It’s actually always based on a set of assumptions.”
For instance, many cost of living calculators will use the regional price of a gallon of gasoline to compare transportation costs. But in some cities, commuters may opt for public transit instead.
“These often don’t necessarily line up with the way different people experience changes in the cost of living,” Parker said.
And of course, they don’t account for quality of life. Maybe housing in one place is more expensive, but the public schools are better.
“So you can look at the different cost of living indexes, but not really understand that some of what you’re paying for in the cost of living is what you’re getting on the other side in benefits,” he said.
It turns out the true cost of living is a little subjective.
Correction (May 30, 2024): A previous version of this story misidentified the organization behind the cost of living index.
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