How Is a Cost of Living Index Calculated?

Cost of living data includes the expenses incurred for food, shelter, transportation, energy, clothing, education, healthcare, childcare, and entertainment. A cost of living index tracks how much basic expenses rise over time and among different regions.

An official cost of living index is not created or reported by the U.S. government, but a few organizations track the costs of living throughout the country.

Understanding a Cost of Living Index

The costs of consumer goods and services vary between urban and suburban residential areas. A person’s salary might provide a high standard of living in a small city in the Midwest compared to the costs incurred in a large city like New York, Los Angeles, or Boston. $100 may purchase more goods and services in Iowa than in Texas.

The cost of living can impact a person’s choice of work and where to live and affect the ability to save for a home or pay off college debt. A cost of living index can track changes in basic expenses and demonstrate how need-based expenses vary from one city or town to another.

How a Cost of Living Index Works

Most indexes set a base cost of living, often represented by 100. The base can be the cost of living in one region or the average of multiple regions. Chicago could be pegged as the base city, and other regions are measured against the base and assigned a cost of living number accordingly. If it is 20% more expensive to live in Boston than in the base city, Chicago, Boston’s cost of living number is 120.

The average income for a geographic area is a factor in evaluating a region’s cost of living. A small town in the rural south might have a lower cost of living than most towns on the east or west coasts. However, the southern town’s median income might be below the cost of living for that area.

Examples of Cost of Living Indexes

Economic Policy Institute

The Economic Policy Institute provides families with updated cost of living data for various cities and towns throughout the U.S. with a helpful Family Budget Calculator. The calculator helps families measure the differences in the cost of living for geographic locations and weighs the costs of food, housing, child care, transportation, and health care.

The calculator found that San Francisco was the most expensive city for parents with two children. The cost of living was estimated at slightly more than $148,000 per year, while the median income for San Francisco was approximately $104,000 per year. Although a salary of $104,000 is attractive, it doesn’t cover the cost of living in the city.

ACCRA COLI

The ACCRA Cost of Living Index or ACCRA COLI is designed to compare the living expenses for various regions of the country. The index measures consumer spending on housing, utilities, groceries, health care, and transportation.

The quarterly publication is compiled and produced by the Council for Community and Economic Research. For the third quarter of 2022, the report showed that Manhattan, New York had the highest cost of living, followed by Honolulu, HI. Harlingen, TX had the lowest.

Social Security Administration’s COLA

A Cost of living adjustment (COLA) is made each year for retirees receiving Social Security benefits. The adjustment is based on the inflation rate, which represents the pace of rising prices.

If a retiree earns $20,000 per year in benefits and inflation rises by 3% per year, the purchasing power of the income is decreased. Over a five-to-ten-year period, the percentages can add up to a substantial reduction in income in real terms by factoring in inflation.

The COLA is designed to increase the benefits paid each year to keep pace with inflation as measured by the Consumer Price Index (CPI). The CPI is the average price of a basket of basic goods and services that are selected to measure rising prices in an economy. CPI includes prices for housing, apparel, transportation, education, food, and beverages. Below is a table from the Social Security Administration detailing the cost of living adjustments each year since 1975.

CPI vs. Cost of Living Index

There are limitations to using CPI as an index since it does not measure the actual costs of living in a given area or region. A typical cost of living indicator shows changes in costs over time that are required to maintain a specific standard of living.

A cost of living indicator factors in changes in consumer buying that stem from economic conditions, adjustments in spending, and habits that people make, such as using alternative products when a product becomes prohibitively expensive. The process of shifting expenditures is commonly referred to as substitution.

The Bottom Line

Cost of living indexes compare the expenses of one geographic region to another and measures the cost of food, shelter, transportation, energy, clothing, healthcare, and childcare. The Economic Policy Institute and the Council for Community and Economic Research provide indexes relative to the United States. A cost of living adjustment, COLA, is issued by the Social Security Administration annually and reflects the inflation rate.