The Cost of Living and Its Effect Upon Real Income

The changes that take place in the prices of commodities cause changes in the cost of living of the consumer. The term cost of living is, however, somewhat ambiguous. The cost may refer to the money expenses of living, which is the sense in which the term will be employed here, except where specific exceptions are made, or it may refer to the effort or real cost involved in procuring the means of living. Thus, if the prices of products purchased by the consumer remained the same and his wages for the same effort were increased, we would say that the real cost of living had fallen, for he could now procure the same things for less effort. There can be no such thing as the cost of living, meaning a single general cost of living. There are many different manners of living and each of these will have a different cost. We do not gain much of an idea of these costs simply by comparing the expenditures and incomes of people, since all we find then is that those with large incomes have large expenditures and, hence, high cost of living. It is necessary, in consequence, to set up some outside measure of living, not related to income or prices, for determining what the costs of living are. There will be many of these costs of living, since there will be many different ways of living.

1. Measurement of the Cost of Living. A usual way of measuring costs of living is to set up a certain quantity of goods, which reflect. a particular way of living, or constitute the measurable items of a certain way of living, and price these goods. For example, the U.S. Bureau of Labor Statistics determined a minimum standardquantity budget which in its judgment represented the quantities of goods needed to maintain a family of five at the minimum level of health and decency. This budget was priced in many places and used to determine the cost of living at a minimum standard. Most studies of this sort have been of costs at a minimum standard. A few, however, include other standards; for example, in general the National Industrial Conference Board studies have included a more liberal standard as well as a minimum standard.

Changes in the cost of living, like changes in the general price level, are customarily measured by index numbers. There are two important index numbers of the cost of goods and services bought by lowincome city dwellers in the United States, and one of the cost of things bought by farmers for family living. One of the indexes for city dwellers is prepared by the U.S. Bureau of Labor Statistics and the other by the National Industrial Conference Board. The index of the cost of things bought by farmers for family living is prepared by the U.S. Department of Agriculture. None of these indexes proceeds exactly upon the basis of pricing a specific bill of goods at different times and places. Instead, certain items of each of the budget groups are priced and an index of the changes of each budget group is determined. These are then combined to give the general index by weighting them according to the relative importance of each group as disclosed by certain budget studies.

2. Changes in the Cost of Living in the United States. The consumer price indexes for the United States as estimated by the U.S.

3. Measurement of Real Income. When prices rise, the quantity of goods that can be bought in the market with a dollar declines. The converse holds true when prices fall. The quantity of goods which the dollar will command at any time is known as the purchasing power of the dollar. The dollar will have varying purchasing power, depending upon the sorts of goods that are purchased with it. The goods that are significant for the ordinary consumer are fairly well represented by those comprising the consumer price index of the Bureau of Labor Statistics, and the purchasing power of the consumer's dollar will fluctuate inversely to this index. If we divide the consumer price index in the base period by the index in the given or compared period, the result will be an index of the purchasing power of the consumer's dollar relative to the base period.

The income of the consumer in terms of dollars may have risen or fallen over a period of time along with changes in the cost of goods and services. His ability to buy goods at any one time depends both upon the purchasing power of his dollar and the number of dollars which he has available for expenditure. If his income has risen more than the cost of goods and services, then he is able to buy more goods and services, but if it has risen less than prices he will be able to buy less with it. Similarly, on a decline, if prices decline more rapidly than his income, he can buy more; but if prices decline less rapidly, then he will be able to buy less. If incomes are reduced to an index with the same base period as the consumer price index, a division of the index of income by the consumer price index in the given period will result in an index of the purchasing power of the consumer relative to the base period.

Source: The Consumer and the Economic Order