Definition and Purpose
A cost of living index measures the relative expense of maintaining a certain standard of living in different locations. It typically compares prices of a standardized basket of goods and services - housing, food, transportation, healthcare - across cities or countries, using one location as the baseline (often 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 typically dominates the index, often accounting for 30-40% of the total weight. Food, transportation, utilities, and healthcare make up most of the remainder. 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, always consider the local cost of living. Earning in the top 20% in Tokyo means something different from the top 20% in Bangkok. A meaningful comparison requires dividing income by the local cost of living index to arrive at a purchasing-power- adjusted figure.