Revision - Cost of Living

The cost of living is a measure of changes in the average cost for a household of buying a basket of different goods and services. Percentage changes in the cost of living are measured by the inflation rate and in the UK there are two officially published measures, the Retail Price Index (RPI) and the Consumer Price Index (CPI).

The UK Statistics Commissions works out the RPI and CPI by tracking the prices in a basket of 650 goods and services. The statisticians attempt to draw a picture of what a typical person in Britain might buy and work out an average level of inflation. Each year the items are changed to reflect the shifting tastes. The weights in the cost of living measurements are also periodically changed to reflect the evolution of spending patterns.

As William Keegan points out in this article in the Observer (24th May 2009), since January 1987, the cost of living in this country, for all the various counter-inflation policies, has more than doubled.

Price data is used in many ways by the government, businesses, and society in general. They can affect interest rates, tax allowances, wages, state benefits, pensions, maintenance payments and many other ‘index-linked’ contracts.

The CPI is a thorough indicator of consumer price inflation for the British economy but there are some weaknesses in its usefulness for some groups of people.

1. The CPI is not fully representative: Since the CPI represents the expenditure of the ‘average’ household, inevitably it will be inaccurate for the ‘non-typical’ household, for example, 14% of the index is devoted to motoring expenses - inapplicable for non-car owners. Single people have different spending patterns from households that include children, young from old, male from female, rich from poor and minority groups. We all have our own ‘weighting’ for goods and services that does not coincide with that assigned for the consumer price index.

2. Housing costs: The ‘housing’ category of the CPI records changes in the costs of rents, mortgage interest, property and insurance, repairs. It accounts for around 16% of the index. Housing costs vary greatly from person to person, from the young house buyer, mortgaged to the hilt, to the older householder who may have paid off his or her mortgage.

3. Changing quality of goods and services: Although the price of a good or service may rise, this may be accompanied by an improvement in quality as the good. It is hard to make price comparisons of, for example, electrical goods over the last 20 years because new audio-visual equipment is so different from its predecessors. In this respect, the CPI may over-estimate inflation. The CPI is slow to respond to the emergence of new products and services.
Since 2007, people have been able to log on to the Office of National Statistics website to use their own personal inflation calculator!