Definition and Purpose
A cost of living index measures the relative expense of maintaining a certain standard of living in different locations. It compares prices of a standardized basket of goods and services - housing, food, transportation, healthcare - across cities or countries, using one location as the baseline (for example, New York City = 100).
Relationship to Purchasing Power Parity
While PPP converts currencies based on what they can buy, cost of living indices focus on the actual expenses faced by residents. A city may have high nominal wages but an even higher cost of living, resulting in lower real purchasing power than a cheaper city with moderate wages.
For international income comparisons, adjusting for cost of living reveals whether a higher salary actually translates to a better material lifestyle.
Components and Weighting
Housing, food, transportation, utilities, and healthcare make up the bulk of the basket. Different indices use different weightings, which is why rankings from Numbeo, Mercer, and the Economist Intelligence Unit can produce different city orderings.
Using the Index for Self-Assessment
When comparing your income rank internationally, consider the local cost of living. Earning in the top 20% in Tokyo means something different from the top 20% in Bangkok. One way to compare is to divide income by the local cost of living index to reach a purchasing-power-adjusted figure.