Inflation measures how prices change for goods and services. When inflation is positive, or greater than 0.0, it means that prices have gone up for the same products or services. Cost of living measures what you pay to maintain an overall lifestyle. Inflation can cause your cost of living to increase through increased costs of the products you buy, but the relationship isn’t direct and costs of living are determined by many subjective choices. If you’re worried that your costs are increasing and what it means for your investments and future retirement, you may want to consult with a financial advisor.
What Is Inflation?
Inflation measures how prices change for similarly situated goods and services over a period of time. It does not measure price changes based on how new products perform or based on price expectations. When a broad measure of prices increase, it’s known as inflation. When a broad measure prices go down, it’s known as deflation.
For example, if the price of a gallon of whole milk increases from $1 to $1.10, this would be considered 10$ inflation, with $0.10 being 10% of the original cost of $1. However, say that instead, the supermarket began stocking organic milk that cost $1.10 per gallon. Even though prices had gone up, this wouldn’t be considered inflation because the price change, at least theoretically, reflects a different product and perceived higher quality.
Economists measure inflation in many different ways, ranging from the price of individual products to the average prices across an entire economy. When news outlets report on inflation overall, they’re referring to average inflation across the entire economy as measured by the Bureau of Labor Statistics.
Every month the BLS publishes its inflation report. Again, this report measures inflation in a number of different ways because inflation varies by factors such as region, industry, product, etc. However, the two most important factors are:
- CPI: The CPI, or the “Consumer Price Index,” measures how national prices change over time for some of the products and services that consumers buy most often. The CPI is built to reflect actual consumer experiences. When it goes up, it typically means that your trip to the market has gotten more expensive.
- Core Inflation: Core inflation measures how national prices change over time for some of the products and services that consumers buy most often – except for food and energy prices. Core inflation is built to reflect the productive capacity of the economy. When it goes up, it means that your trip to the market has gotten more expensive because demand for products currently outstrips the country’s ability to supply those goods.
What Is Cost of Living?
The cost of living is how much someone spends on their day-to-day life. This is also described as the costs involved with maintaining a given lifestyle. A household’s costs of living generally include all of their major costs, measured on a monthly basis, such as rent, food, transportation, utilities and bills, healthcare and other frequent expenses. For example, if you spend $1,200 per month on your apartment and another $250 per month on groceries, your cost of living will include at least $1,450 per month.
A cost-of-living calculation focuses on individuals and households, although like inflation you can measure it in many different ways. For example, an individual can determine their own personal costs of living. Or you can measure the average costs of living by lifestyle, for example, the average cost of living for someone with a one-bedroom apartment or the average cost of living for a family with two parents and two children. You can also measure costs of living by area, for example, the average cost of living in Boston or New York.
This makes costs of living far more difficult to pin down. Unlike inflation, this is a very subjective measure and results can vary widely based on factors such as:
- Region: Perhaps the biggest variable of all, since costs range widely based on where you choose to live. Someone’s costs of living are going to be far higher in San Francisco than in the Upper Peninsula.
- Household: Someone living on their own will have far fewer expenses than two spouses or a family with children.
- Lifestyle: How you choose to live will determine your cost of living, whether that means buying a downtown brownstone or living in a studio apartment.
Difference Between Inflation vs. Cost of Living
The most important difference between the cost of living and inflation is this: Cost of living is subjective and can be individual. While you can measure the average cost of living among groups of people, especially in the same geographic area, it’s ultimately a personal finance concept that measures how much an individual’s living costs are. Inflation is universal and tied to specific economies. It’s a macroeconomic concept that measures how the price of goods and services changes for everyone.
Inflation can cause costs of living to rise, although this isn’t a one-to-one relationship. When prices rise for necessities, such as medication and rent, inflation almost always pushes up someone’s costs of living. When prices rise for discretionary spending, people will often balance their lifestyle choices with cost-cutting. Put another way, they will adjust to a rising cost of living by reducing their standard of living.
Bottom Line
Inflation occurs when prices rise for the same set of goods and services. Cost of living is how much you spend on those goods and services to maintain your standard of living. Inflation can push costs of living up, by making things more expensive, but it isn’t a direct relationship.
Tips for Managing Personal Finances
- Figuring out how to manage your finances and what to do when the cost of living or inflation increases can be a lot. Working with a financial advisor can help ease the burden and give you peace of mind in protecting your wealth. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- What does it cost to live in your area? More importantly, what will it cost to live in your area? Whether you’re thinking about moving somewhere new or getting a bigger place, run the numbers through our calculator to see what you’ll need for your lifestyle.
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