Introduction

Source: https://www.nationmaster.com/cost-of-living

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One of the common phrases we always tend to hear whenever there is a change in wholesale/consumer/retail inflation level or increase in fuel is that “the cost of living has increased a lot”.

Same way if you have noticed there will always be a different paycheck for the same position in different cities based on its “cost of living”.

In this blog, we will have a snippet on the cost of living index.

What is the cost of living?

Source: https://www.patriotsoftware.com/blog/accounting/average-cost-living-by-state

The cost of living is the amount of money needed to cover the basic expenses in a certain place and time.

Basic expenses can include housing, food, taxes, health care, clothing, education, entertainment, and transportation.

Cost of Living Index

The cost of living is always linked to the income earned and used to compare the livability in different cities. 

As prices vary from one city to the next, the cost of living helps you determine how affordable it is to live in a specific city or region.

Example: The price of diesel and petrol will vary in metro cities and rural areas. Even among the metros like Chennai, Delhi, Mumbai, Bangalore and so on the price varies

Cost of living is calculated by comparing the prices of a range of goods and services on which consumers spend their money. 

Costs are broken down by category, like health care, food, and housing, and weighed based on their spending patterns and individual budgets.

The cost of living in the base city is always expressed as 100. The cost of living in the destination is then indexed against this number. 

For example, if Chennai is the base (100) and Bangalore is the destination, and the index is 120, then Bangalore is 20% more expensive than Chennai.

Similarly, if Chennai is the base (100) and Madurai is the destination with the index number 80, then Madurai is 20% less expensive than Chennai.

Cost-of-living index (2022)

Source: https://www.asean.mercer.com/newsroom/2022-cost-of-living-survey.html

Source: https://www.asean.mercer.com/newsroom/2022-cost-of-living-survey.html

Cost of Living Adjustment (COLA)

Cost of living adjustment is an increase in income pay that is tied to some measure of economic activity and keeps up with the cost of living. 

It’s often applied to wages, salaries, and benefits which include union agreements, executive contracts, and retiree benefits.

Employment contracts and pension benefits can be tied to a cost-of-living index, typically to the consumer price index (CPI).

Methods of constructing Cost of Living Index Number

The cost-of-living index number can be constructed by the following methods,

1. Aggregate Expenditure method/weighted aggregative method
2. Family Budget Method

1. Aggregate Expenditure method/weighted aggregative method 

This is the most common method used to calculate the cost-of-living index number.

In this method, weights are assigned to various commodities consumed by a group in the base year. 

In this method, the quantity of the base year is used as weight.

The formula is given by,

Note

The formula for the Aggregate Expenditure Method to calculate the Cost-of-Living Index Number is the same as the formula of Laspeyres Method.

2. Family Budget Method

In this method, the weights are calculated by multiplying prices and the quantity of the base year. (i.e.) V = ∑ p₀ q₀. 

Note

This method is the same as the weighted average of the price relative method.

When to Use?

1. When the Price and Quantity are given, Laspeyres Index Method/Aggregate Expenditure Method is used.
2. When the Price and Weight are given, the Family Budget Method is used.

Difference between cost of living and standard of living

Source: https://goprep.co/differentiate-cost-of-living-from-the-standard-of-living-i-1nldl7

Difference between Cost of living and Inflation

Source: http://www.differencebetween.net/business/economics-business/difference-between-cost-of-living-and-inflation/

Conclusion

There are many websites like https://www.numbeo.com/cost-of-living/country_result.jsp?country=India,  https://www.expatistan.com/cost-of-living/country/india where you can check the cost of living in a particular city with the specified budget and income you earn to understand the concept better.

Hope you enjoyed reading the blog. See you soon.