Cost-of-Living-Based Measures of Poverty

COST-OF-LIVING MEASURES exist for two fundamental reasons. First, they are a means of comparing the relative purchasing power of income across geographical regions. For example, the amount of income it would take to maintain a certain standard of living in New York City would be different from the amount required to maintain a similar standard of living in Dallas, Texas. Second, in order for certain public policies to be consistent across states or regions, it is often necessary to use cost-of-living measures to develop equality across these areas. For example, when developing policies aimed at creating income parity among states on salaries, it is important to determine the true difference in income in order for the policy to be consistent for every state.

Because cost of living is based on the purchasing power of income, it is closely tied to rates of inflation and deflation. The U.S. government uses a cost-of-living measure prepared by the U.S. Bureau of Labor Statistics known as the Consumer Price Index (CPI) to calculate the rise and fall of prices in the economy. The CPI measures the average change in prices paid for a fixed market basket of consumer goods and services over a specified period of time.

The market basket is composed of such goods and services as food, housing, transportation, medical care, recreation, and education. The CPI is expressed as a percentage of change in the cost of a market basket from one year to another. For example, consider that the market basket price for 1980 was $100. A market basket price of $160 in 2000 would suggest a 60 percent increase in the cost of living from 1980 to 2000. This percentage of change in the CPI is referred to as the inflation rate.

The CPI is calculated for different geographical areas and income levels. The Consumer Price Index for All Urban Consumers (CPI-U) is based on residents of urban and metropolitan areas and represents 87 percent of the U.S. population. The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is a subset of the CPI-U and represents households where more than one-half of the income is from clerical or wage occupations and one household member has worked at least 37 weeks in the previous 12 months. The CPI-W accounts for approximately 32 percent of the population.

The CPI is closely monitored by policymakers and employees whose wages vary with the economy. The practice of indexing wages to the CPI, known as Cost of Living Adjustment (COLA), was designed to offset changes in purchasing power as measured by the CPI and is built into many employee contracts.

Disparity exists over whether the CPI is an accurate measure of cost of living. Some authors suggest that because it does not measure factors that affect consumer well-being, such as crime, and that it is based on averages that do not reflect the experience of any one family, it is not an accurate measure of cost of living. These authors favor other measures, such as the social-cost-of-living index, which estimates economic demand based on the underlying welfare functions of consumers.

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