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

What Is the Cost of Living?

The cost of living refers to the money needed for essentials like housing, food, taxes, and healthcare in a specific location and time. It is often used to compare the expenses of living in different cities. Higher living costs, like in New York, require higher salaries for affordability.

How the Cost of Living Is Used

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. Changes in the CPI are often a triggering event in labor and other contracts with escalation clauses. The contract will detail exactly how any periodic adjustments happen and what parts of the contract will change.

In a 2024 survey, Mercer, a global human resources firm, finds the cities with the highest cost of living in order are Hong Kong, Singapore, Zurich, Geneva, and Basel.

New York City was ranked the costliest city in the United States followed by Los Angeles, Honolulu, and San Francisco.

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 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.

Mercer's cost of living index measures prices in 226 urban areas for a basket of goods, which includes 12 large eggs, one liter of olive oil, espresso coffee at a popular cafe, one liter of gasoline (unleaded 95), men's blue jeans, and women's shampoo, haircut, and styling.

The Economic Policy Institute updated its Family Budget Calculator in January 2024 with data from 2023. The calculator helps families determine how much salary they will need to cover the cost of living in 3,143 counties in all 613 metro areas.

Most Expensive Urban Areas in the U.S.

According to The Council for Community and Economic Research, the 10 most expensive urban areas in the U.S. in 2023 were:

1. New York, (Manhattan), NY
2. Honolulu, HI
3. San Jose, CA
4. San Francisco, CA
5. New York (Brooklyn), NY
6. Orange County, CA
7. Los Angeles (Long Beach), CA
8. Washington D.C.
9. Boston, MA
10. Seattle, WA
    

Least Expensive Urban Areas in the U.S.

According to The Council for Community and Economic Research, the 10 least expensive urban areas in the U.S. in 2023 were:

1. Decatur, IL
2. Harlingen, TX
3. McAllen, TX
4. Tupelo, MS
5. Ponca City, OK
6. Muskogee, OK
7. Conway, AR
8. Florence, AL
9. Kalamazoo, MI
10. Lawton, OK

U.S. States Ranked by Cost of Living

U.S. states, districts, and territories ranked by cost of living from lowest to highest as of Q1 2024 as provided by The Council for Community and Economic Research is as follows:

1. West Virginia
2. Oklahoma
3. Kansas
4. Alabama
5. Mississippi
6. Missouri
7. Arkansas
8. Iowa
9. Indiana
10. Tennessee
11. Georgia
12. Michigan
13. Louisiana
14. Texas
15. Kentucky
16. North Dakota
17. Illinois
18. Nebraska
19. South Dakota
20. New Mexico
21. Ohio
22. Montana
23. Minnesota
24. Wyoming
25. Pennsylvania
26. Wisconsin
27. South Carolina
28. North Carolina
29. Delaware
30. Idaho
31. Virginia
32. Colorado
33. Puerto Rico
34. Nevada
35. Utah
36. Florida
37. Arizona
38. Maine
39. Connecticut
40. Rhode Island
41. New Hampshire
42. New Jersey
43. Oregon
44. Vermont
45. Washington
46. Maryland
47. New York
48. Alaska
49. Massachusetts
50. District of Columbia
51. California
52. Hawaii

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.

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 2022, the COLA was 8.7% due to the high levels of inflation as a result of the COVID-19 pandemic, and the increased amounts were paid starting in January 2023. 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.

The Bottom Line

The cost of living refers to the expenses required to sustain a particular standard of living, including housing, food, taxes, and healthcare. It serves as a benchmark for comparing expenses across different areas and informs decisions about salaries and relocations.

A cost of living index aggregates these expenses, offering a detailed measure that helps individuals understand the financial requirements of different locations.

Rising living costs have ignited debates about wage increases and the need for cost-of-living adjustments. These measures seek to ensure that earnings are in step with inflation so that purchasing power is not reduced and economic stability is maintained.