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Difference Between Cost of Living and Inflation

In the recent past, people have to spend more than they would a few years ago to afford a similar lifestyle. This can be interpreted as a high cost of living due to inflation. While the terms cost of living and inflation are closely related and used interchangeably, they are different in various ways.

 

Cost of living

This is the cost associated with maintaining a certain lifestyle, which varies with places, persons and even cities. Factors used to measure the cost of living include food, healthcare, housing, taxes, and transportation. The cost of living differs in various locations in the world, with some places having low costs of living while others have high costs of living. The information on the costs of living is essentially useful in determining the affordability of places.

To measure this, two tools are used:

  • Cost of living index- First published in the year 1968, it measures the cost of living at different time frames in a country in consideration of the cost of services and goods, while allowing for the substitution with other related items.
  • Purchasing power parity- While this is considered a complex measure of the cost of living, it is based on the differences between the currencies purchasing power to the ratio of the currencies exchange rates in respective places.

 

Inflation

This is an increase in the price levels of services and goods over time in an economy. With the increase in prices, a unit of currency buys fewer services and goods hence reducing the purchasing power of a unit of money. Although inflation is generally known for the negative effects in an economy, it also has positive impacts in an economy.

Types of inflation include:

  • Price inflation- This is an increase in the price of consumer goods and services
  • Red inflation- Refers to the loss in the purchasing power parity

The negative effects include;

  • The opportunity cost associated with holding money increases
  • Discouragement of savings and investments due to uncertainty over future inflation
  • Shortages of consumer goods and services which encourages hoarding

The positive effects include;

  • Reduction in unemployment as a result of nominal wage rigidity
  • Inefficiencies associated with deflation are avoided
  • Encourages investment and loans as opposed to money hoarding

Consumer Price Index (CPI) is used to measure inflation through an average of a basket of goods including medical care, transportation, and food.

 

Similarities between Cost of Living and Inflation

  • Both impacts economies as well as economic activities in various ways

 

Differences between Cost of Living and Inflation

Definition

Cost of living refers to the cost associated with maintaining a certain lifestyle, which varies with places, persons and even cities. On the other hand, inflation refers to an increase in the price levels of services and goods over time in an economy.

Tools of measure

The cost of living is measured using the cost of living index and the purchasing power parity tools. On the other hand, inflation is measured using the Consumer Price Index.

Boundaries

While the cost of living is evaluated based on states, regions, countries, and cities, inflation is evaluated based on individual countries.

Economic effects

Cost of living affects the mobility of resources in respective areas. On the other hand, inflation impacts the whole economy.

Cost of Living vs. Inflation: Comparison Table

 

Summary of Cost of Living vs. Inflation

Cost of living refers to the cost associated with maintaining a certain lifestyle, which varies with places, persons and even cities and is measured using the cost of living index and the purchasing power parity tools. On the other hand, inflation refers to an increase in the price levels of services and goods over time in an economy and is measured using the Consumer Price Index. Although the two differ in various ways, they both have economic effects.

 

Tabitha Njogu

Tabitha graduated from Jomo Kenyatta University of Agriculture and Technology with a Bachelor’s Degree in Commerce, whereby she specialized in Finance. She has had the pleasure of working with various organizations and garnered expertise in business management, business administration, accounting, finance operations, and digital marketing.

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References :


[0]Image credit: https://www.flickr.com/photos/30478819@N08/46688178665

[1]Image credit: https://www.flickr.com/photos/30478819@N08/45871042585

[2]Donovan Paul. The Truth About Inflation. Routledge Publishers, 2015. https://books.google.co.ke/books?id=1aasBwAAQBAJ&printsec=frontcover&dq=Difference+between+Cost+of+Living+and+Inflation&hl=en&sa=X&ved=0ahUKEwjZweas4ZjkAhWztHEKHda4BNMQ6AEILjAB#v=onepage&q=Difference%20between%20Cost%20of%20Living%20and%20Inflation&f=false

[3]Mankiw N. Principles of Economics, Volume 1. Cengage Learning Publishers, 2008. https://books.google.co.ke/books?id=oRgQ2goeFzwC&pg=PA13&dq=Difference+between+Cost+of+Living+and+Inflation&hl=en&sa=X&ved=0ahUKEwjZweas4ZjkAhWztHEKHda4BNMQ6AEITjAG#v=onepage&q=Difference%20between%20Cost%20of%20Living%20and%20Inflation&f=false

[4]Gowran S. Opening Doors: School and Community Partnership in Poverty Awareness and Social Education Initiatives. Combat Poverty Agency, 2005. https://books.google.co.ke/books?id=A0ZaTlKjHYcC&pg=PA12&dq=Difference+between+Cost+of+Living+and+Inflation&hl=en&sa=X&ved=0ahUKEwjZweas4ZjkAhWztHEKHda4BNMQ6AEIQDAE#v=onepage&q=Difference%20between%20Cost%20of%20Living%20and%20Inflation&f=false

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