Question

Measuring The Cost of Living Discussion Question:

How to measure the cost of living?

What are the issues of measuring the cost of living by using CPI?

1) A brief summary of your ideas of how to measure the cost of living.

2) What are the issues of measuring the cost of living by using CPI?

Answer 1

How to measure the Cost of Living

The measurement to monitor the changes in the cost of living over time is called the Consumer Price Index (CPI). It represents the selected market basket. In order to maintain the same standard of living the family has to spend more money when the CPI rises. The ultimate goal of the CPI is to measure the changes in the cost of living. CPI does not intend to measure the actual cost of living in any given area but only loosely measures inflation and tracks the basket of consumer goods over a period of time. It also measure the changes in the spending capacity of the people.

Cost of living index helps to compare the expenses an average person can spend on the food, shelter, transportation, energy, clothing, education, healthcare, child care, entertainment etc. A base cost of living is set, mostly it is represented by 100. A particular region is selected and the CPI is allotted to that area and the cost of living of all other areas or surrounding areas are calculated as per that CPI. It can also be an average of multiple regions. That is called base CPI and the region is called as the base region. Eg.:- If the base region is A and the CPI is 100, if the region B is 25% more expensive than A then the region B's cost of living will be 125.

Issues of measuring Cost of Living by using CPI

• Though CPI is followed by religiously but it is not a perfect measure of either inflation or the cost of living and it has many inherant weaknesses.
• It does not provide an index that measures all production or consumption in the economy but only covers a basket that is selected or a certain region. Thus, it is not accepted as a basic economic barometer.
• It is not effective in the substitution effect. When there is substitution effect, CPI does not consider that and assumes that even in price rise people continue to buy the same product.
• New products are not taken into account. The CPI remains same for few years, meanwhile if any new products are launched then it does not become a part of the CPI, unless it becomes the staple of the people.
• CPI is used as an indicator of inlfation but it does not calculate the level of inflation very well too. Other indicators of measuring the buying power showed a dramatic change but CPI remained constant.
• CPI is designed to calculate the cost of living of the urban areas in particular so there are criticisms that it does not cover the cost of living pattern of the rural areas and it does not provide separate reports as per the demographic changes.
• Only certain goods are put into the selected basket and CPI is calculated but it does not check on the quality of the goods.