Cost of Living: Definition, How to Calculate, Index, and Example

What Is the Cost of Living?

The cost of living is the amount of money needed to cover basic expenses such as housing, food, taxes, and healthcare in a certain place and time period. The cost of living is often used to compare how expensive it is to live in one city versus another. The cost of living is tied to wages. If expenses are higher in a city, such as New York, for example, salary levels must be higher so that people can afford to live in that city.

Cost of Living and Lifestyle

The cost of living can be a significant factor in personal wealth accumulation because a salary can provide a higher standard of living in a city where daily expenses such as rent, food and entertainment are less. In contrast, a high salary can seem insufficient in an expensive city such as New York. In a 2018 survey, Mercer, a global human resources firm, finds the cities with the highest cost of living include Hong Kong; Luanda, the capital of Angola; Tokyo; Zurich and Singapore, in that order. New York City was ranked the costliest city in the United States followed by San Francisco and Los Angeles, Chicago, Washington and Boston.

The Cost of Living Index

The cost of living index compares the cost of living in a major city to a corresponding metropolitan area. The index incorporates the expense of various living expenses creating an aggregate measure that workforce entrants can use as a benchmark. As college graduates weigh employment alternatives and currently employed job seekers consider relocation, the index provides an informative snapshot of rental, transportation and grocery costs.

Different indexes may calculate living expenses differently. For example, in 2018, Kiplinger found San Diego to be the most expensive city based on the Council for Community and Economic Research, not New York City. The Council's cost of living index measured prices in 269 urban areas for expenses such as housing, groceries, utilities, transportation and healthcare, even getting a haircut or going to a movie. In the case of San Diego, the cost of housing is 138% above the national average, and the cost of transportation is over 20% higher than the national average.

Four out of five of the world’s most expensive cities for expatriates are now in Asia.

Cost of Living and Wages

The rising cost of living has spurred debate over the U.S. federal minimum wage and the disparity between the lowest salary allowed by law and the earnings needed to maintain an adequate cost of living. Proponents of a hike in wages cite increased worker productivity levels since 1968 as inequitably correlated to the minimum hourly rate of pay. As pay levels once tracked the increase in productivity, the divergence between earnings and worker efficiency has reached historically disproportionate levels. By contrast, opponents of a minimum wage contend that a raise could spur higher consumer prices as employers offset rising labor costs.

Multinational corporations use cost of living to assess expatriate salary packages for international assignees.

Wage Increases and Cost-of-Living Adjustments (COLAs)

In 1973, Congress enacted legislation to address cost-of-living adjustments (COLAs). COLA adjustments for Social Security and Supplemental Security Income (SSI) benefits were instituted so that the payments keep pace with inflation. For example, in December 2018, the COLA was 2.8% and the increased amounts were to be paid, starting in January 2019. Federal SSI payment levels increased by the same percentage.

The Social Security Act requires COLAs to be based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The Social Security Administration states that:

A COLA effective for December of the current year is equal to the percentage increase (if any) in the CPI-W from the average for the third quarter of the current year to the average for the third quarter of the last year in which a COLA became effective.

Key Takeaways

  • Cost of living is the amount of money needed to sustain a certain standard of living by affording expenses such as housing, food, taxes, and healthcare.
  • Salaries should reflect the higher cost of living in more expensive cities like New York City.
  • The cost of living index compares the cost of living in a major city to a corresponding metropolitan area.

Real World Example

The Economic Policy Institute updated its Family Budget Calculator in March 2018. The calculator helps families determine how much salary they will need to cover the cost of living in 3,142 counties in all 611 metro areas.

The calculator finds San Francisco to be the most expensive city and a two-parent household with two children would need a total income of $148,439 with a basic budget for expenses. The least expensive metro area was Brownsville, Texas where the same family would need a median income of $32,203. Interestingly, there is nowhere in the United States where a single adult with no children would be able to cover the cost of living earning the minimum wage.

Article Sources
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  1. Mercer. "Mercer’s Annual Cost of Living Survey Finds Asian, European, and African Cities Most Expensive Locations for Employees." Accessed Sep. 20, 2020.

  2. SSA. "Computation of Primary Insurance Amount." Accessed Sep. 20, 2020

  3. Economic Policy Institute. "Family Budget Calculator." Accessed Sep. 20, 2020.

  4. MIT. "Bare Facts About the Living Wage in America 2017-2018." Accessed Sep. 20, 2020.