Cost of living : meaning, calculation and main causes of price increases

Introduction

The cost of living is the sum total of expenses that a person must incur to maintain the same standard of living in situations that differ only by price variations.

In other words, it is the amount of money needed to cover basic expenses such as housing, food, taxes, health care and even getting a haircut or going to the cinema, and this in a certain place and for a certain period of time.

So, how do we define the cost of living, why is it increasing, and how does this influence the purchasing power Households?

I- Defining and understanding the cost of living

Generally, the concept of cost of living is very prominent in the field of public economics.

It is the calculation or estimation of the goods and services that households need to consume to achieve a certain degree of satisfaction or to reach a certain standard of living, that is to say the assessment of the average cost of household consumption expenditure in a given region.

1- The cost of living, a global concern

Indeed, the main problem with the cost of living lies in the difficulty of making exact calculations, since household satisfaction is based on subjective elements.

It should be noted that the cost of living depends on many factors. It therefore varies according to the geographical area of ​​the country and from one country to another.

Thus, it is higher in developed countries than in developing countries, and also depends on whether the country is rich or poor.

Moreover, variations in the cost of living are measured by means of an index that incorporates the cost of various subsistence expenses, thus creating an overall measure that can be used as a benchmark reflecting the real cost of goods and services considered necessary for life in general.

In general, the concept of cost of living, for each household refers to the sum of these two components :

• The non-tax component : that is, all expenditure on goods and services, excluding any tax,

• The tax component : that is, the taxes, duties and other fiscal contributions that households must bear

It should be noted that the location is one of the most important factors affecting the cost of living. Different regions have different prices for goods and services, depending on various factors such as supply and demand, taxes, wages, infrastructure and quality of life.

Therefore, wages must reflect the cost of living. So, if expenses are higher in a city, like New York, for example, wages must be higher so that people can afford to live there.

Similarly, unemployment benefits should be based on increases in the index of consumer price.

In this context, multinational corporations use the cost of living, which has the particularity of reflecting differences in purchasing power, to evaluate the salaries of expatriates for international employees.

2- Calculating the cost of living

In fact, the Consumer Price Index (CPI) is commonly used as a reference when discussing the tastes and customs of households in a country or territory.       

Thus, the consumer price index : is an index that measures the change in prices of a list of goods and services in which quantity and quality remain constant.

Indeed, the consumer price index isbased on a basket of representative goods and services, which expands by integrating new products which, over time, are gradually considered necessary for the life of an average family, such as the telephone, radio, television, etc.

In general, the indices are based on a basket of representative goods and services detailed in main spending groups as follows :

• Food
• Clothing and shoes
• Accommodation
• Furniture, appliances
• Hygiene and health
• Transportation
• Communications
• Leisure and culture
• Restaurants and hotels
• Other goods and services

The cost of living would be the amount of money a family needs to access this basket of goods and services within a given period of time.

Moreover, the cost of living index can be influenced by various factors that affect the supply and demand of goods and services, such as :

• The availability of natural resources,
• The level of competition,
• Government policies,
• Environmental conditions
• Cultural preferences.

II- The main causes of the rise in the cost of living

Several factors contribute to the rising cost of living, including examples include :

1- Inflation and the general rise in prices

Indeed, inflation is one of the most important factors affecting the cost of living. Moreover, inflation is defined as the general increase in the prices of goods and services over time, especially when this increase concerns the prices of basic necessities such as energy and food, resulting in a deterioration of the purchasing power of households and particularly low-income people.

This means that the purchasing power of money decreases to the extent that the same amount of money can buy fewer goods and services than before.

2- Supply chains and global trade

Supply chains are the assembly lines that provide goods for final consumption. In our modern economy, supply chains have become very complex and involve many producers worldwide, except that the worrying disruptions due to the COVID-19 pandemic, geopolitical conflicts, wars or economic conflicts such as the exorbitant tariffs applied by the USA to other countries, particularly China have largely threatened the delivery of world trade products by causing an increase in product prices which has negatively impacted the cost of living by pushing it upwards.   

3- Stagnant wages in the face of rising expenses

During periods of high inflation, the prices of goods and services (food, transportation, education, healthcare, etc.) increase, amplifying household expenses.

Conversely, wages, often stagnant ornot sufficiently revalued,tend to lag behind price increases, by causing a decrease in real wages (taking into account the cost of living), which means that households see, and feel, the purchasing power of their income decrease, thus putting a large number of the population in difficulty.

Thus, faced with an inflationary shock, workers will want to increase their wages in order to preserve or increase their real purchasing power, given that rising prices reduce the budgets of the poorest households.

This is why the indexation of social benefits and the minimum wage will play an essential role in preserving the living standards of the least advantaged populations.

Indeed, wage indexation is a crucial mechanism whose ultimate goal is to maintain employees’ purchasing power when the cost of living rises.

However, this mechanism does not allow all workers to cope with price increases, particularly those on lower wages, since the effects of inflation on employees vary significantly depending on changes in their income and their consumption patterns.

Moreover, while inflation may have prompted wealthier households to reduce certain unnecessary expenses, it did not alter their living conditions, whereas it had negative, even dramatic, consequences for the poorest households.

Broadly speaking, while the increase in the cost of living affects everyone, some groups in society are hit harder.

4- Monetary and fiscal policies

Fiscal policy and monetary policy are two policies described as macroeconomic and cyclical.

The policy is macroeconomic because it influences aggregate variables (household consumption, business investment, GDP, employment), and it is cyclical because it acts in the short term.

Moreover, fiscal policy and monetary policy influence the decisions of economic agents (consumption, investment, credit) through various channels (taxation, public spending, interest rates, credit debt).

A- Monetary policy

It is implemented by the Central Bank, and allows for changes in financial conditions by adjusting the money supply through the key interest rate and open market operations, with the aim of keeping inflation at a low and stable level.

In this context, through key interest rates, the central bank exerts influence on the interest rates of commercial banks and, through this, on the cost of credit to households and businesses.

Thus, maintaining high interest rates has multiple consequences for the economy, for example, households, and specifically those who borrow, see the rise in rates as an additional burden of debt service which negatively impacts purchasing power.

Furthermore, the use of exchange rate instruments through the devaluation of the national currency leads to an increase in the price of imported products.This increase in import costs has repercussions in all sectors of the economy, and affects households through the increase in the cost of living.

B- Budgetary policy

It is led by the State, and indirectly influences the price level through its effects on both aggregate demand and aggregate supply (impact on production capacities).

Thus, when growth accelerates, public spending decreases (lower unemployment benefits) and public revenue increases. This automatically has a negative effect on consumption and investment by reducing the purchasing power of economic agents.

Similarly, modifying mandatory levies, for example increasing the income tax rate for households, leads to a reduction in disposable income and therefore in purchasing power.

Conclusion

In conclusion, the cost of living can vary considerably depending on where we live, our lifestyle, and our personal preferences.

Therefore, the true cost of living should only be measured based on the resources acquired in the country where consumption takes place and in the currency used. It is generally associated with another concept, namely purchasing power.