Living is expensive. There are necessary items and services an average person needs so that they can maintain an average lifestyle. The Bureau of Economic Analysis (BEA) breaks up necessary expenses into nine groups—apparel, education, food, housing, medical, recreation, transportation, and other goods and services.
Each of these groups includes the costs that are associated with them. Insurance, vehicle maintenance, toll fees, vehicle licensing and registration, bus or taxi fares, and any other transportation-related costs are included in the transportation group: the housing group includes insurance, maintenance, utilities, rent or mortgage payments, child care, phone bills, or any other cost associated with having a place to live.
It is important to understand how the cost of living is calculated, how to compare different ones, and what the index tells you so that you can decide how far you will be able to make your paychecks go.
How Cost of Living Is Calculated
The cost of living is an index, so your specific expenses might be higher or lower depending on where you live. For example, your fuel expenses would be higher if you live in New York than it would if you live in Mississippi.
Agencies calculate the cost of living by finding prices for a representative sample of goods and services that are necessary for maintaining an average lifestyle. They then take into account how much of a person's budget would be consumed by the item in a year. For example, one gallon of milk might not cost much compared to one dress. But over a year, food would cost more than clothing. So the price for each item is weighted to account for its importance to a typical family's budget.
These expenditures are totaled and averaged, and indexes are created to help compare different locations. The BEA calls these indexes Regional Price Parities (RPPs). Each state and Metropolitan Statistical Area (MSA—a large, populated area) have different RPPs because of the living variables discussed.
A more thorough example is the federal government's official measurement of inflation, the Consumer Price Index. The U.S. Department of Labor measures the prices of approximately 80,000 goods and services from 23,000 retail and service businesses. It then weights the items according to how they are used by a sample of 14,500 families. The CPI excludes income taxes but includes sales taxes.
There are different CPI databases that can be used. The CPI All Urban Consumers database is generally the one that is the most used.
Cost-of-Living Comparison and Index
Measurement indexes are generally used as a baseline for comparisons. A cost-of-living index gives you the percentage of the difference between the cost of living in your current location and another area. In other words, your cost of living is the baseline for you.
Comparing costs-of-living is useful if you are considering moving to another area for work or retirement, as costs will be different depending on the location. It's particularly useful when traveling internationally to compare international locations because a comparison compensates for exchange rate differences.
The cost of living in your area would be the index of the comparison. If you have to live for a time on your usual pay when traveling or moving, you might end up over-budget if you're in a higher cost of living area.
Cost-of-living tools and reports tell you the costs for various categories, such as housing, food, and gas. Keep in mind these are estimates based on survey samples, so your particular cost of living may be significantly different. For example, the Consumer Price Index compares the cost of living between any time period or between major U.S. cities and regions.
The U.S. Department of State also offers links to a variety of resources to help you determine the best place for you to live.
The Economist Intelligence Unit (EIU) provides a cost-of-living survey that compares cities around the world. It takes into account the relative cost of most goods and services.
- Just looking at the cost of living doesn't tell you how easy it is to live in the city. Many factors, such as pollution or crime, don't necessarily create an immediate expense. These factors could simply make the city harder to enjoy. The EIU also provides a Global Liveability Index to assist you.
Highest / Lowest Cost of Living Worldwide
There are more than a few reasons to understand the costs of living around the world—the index can be used to give perspective on the value of their money, help someone decide where to retire; assist policymakers when creating or adjusting policies and legislation on labor, commerce; and can help multinational companies determine salaries.
Mercer 2019 Cost of Living Rankings provides information on the cost of living around the world. According to the site, these are the top 10 most expensive cities in the world. The most expensive city is listed first:
- Hong Kong, HKSAR
- Tokyo, Japan
- Seoul, South Korea
- Zurich, Switzerland
- Shanghai, China
- Ashgabat, Turkmenistan
- Beijing, China
- New York, United States
- Shenzhen, China
The 10 least expensive cities in the world are often in unsafe, poverty-stricken, or war-torn areas. The lowest-cost city is first on the list:
- Tunis, Tunisia
- Tashkent, Uzbekistan
- Karachi, Pakistan
- Bishkek, Kyrgyzstan
- Banjul, Gambia
- Windhoek, Namibia
- Islamabad, Pakistan
- Tbilisi, Georgia
- Skopje, Macedonia
- Managua, Nicaragua
Cost-of-Living Adjustment and Increases
The cost-of-living adjustment (COLA) is the change made to make wages or benefits stay current with the cost of living. The government uses it for federal retirees and recipients of Social Security benefits. The Social Security Administration announced a 1.3% benefit increase for 2021.
Other applications for the costs of living include government workers' benefits, union negotiations, and corporate contracts for valued employees. Private employers sometimes also use the cost of living when employees are asked to relocate to a different location.