Changing Prices: Cost of Living Index
A cost of living index is a hypothetical price index that compares and measures the relative cost of living in regions or different times. The useful purpose of a cost of living index is its ability to measure the differences in the price of services and goods. It also allows for other items being substituted as prices vary.
There are a variety of methods that have been created in order to approximate a cost of living index, which includes different methods that allow substitution between items as relative prices change.
A cost of living index can affect many different things, including pension benefits, employee contracts, and government entitlements like Social Security. Often, the cost of living can cause adjustments to salaries annually based on geographic location.
Sometimes there are also yearly escalation clauses found in employment contracts can include future or retroactive percentage increases in salary which is not based on a cost of living index. These negotiated increases in salary are informally called cost of living increases or cost of living adjustments due to their similarity to other increases related to externally-determined indexes.
In the United States, there is the Consumer Price Index, which is derived from the idea of the cost of living index. The difference between the two is that the cost of living index measures changes in amounts that consumers spend over time on things such as clothing or food, but having a complete cost of living index could go further beyond this aspect and also describe changes such as environmental or governmental factors that have an effect on the well-being of a consumer.
The Consumer Price Index is a statistical estimate made based off the prices of a section or sample of a given item whose costs are periodically collected. Further divisions of sub-indexes and sub-sub-indexes are then generated for different categories as well as sub-categories of services and goods, being grouped to create the overall Consumer Price Index with weight adjustments reflecting their portion in the total of the expenditures by consumers.
It is one of many price cost of living indexes created by various national statistical agencies. The yearly change in percentage in the Consumer Price Index is used as an indication of inflation. It can be used to adjust for the effect of inflation in the actual value of salaries, pensions, wages, monetary magnitudes and price regulation in order to see changes in the actual values.
In most countries, the Consumer Price Index, as well as the USA National Income & Product Accounts and the population census, is one of the most carefully observed national economic statistics.