What does cost of living mean?

A recent news item in the Age is very useful in highlighting the difference between the Consumer Price Index (CPI) and the Australian Bureau of Statistics (ABS) living cost indices. Confused? Read on for our plain-English explanation and how this affects those on an Age Pension and self-funded retirees.

What is cost of living?

There are two broad measures used in Australia for cost of living. They do not measure the same things and therefore should not be considered as interchangeable.
The Consumer Price Index (CPI) in the last calendar year (to December 31) rose 2.7 per cent. This is a measure of price inflation. As the ABS states ‘…CPI is designed to measure price inflation for the household sector as a whole and is not the conceptually ideal measure for assessing the changes in the purchasing power of the disposable incomes of households.’

By contrast with the CPI, the living cost index reflects changes over time in the purchasing power of the after-tax incomes of different types of households. It measures the impact of changes in prices on the out-of-pocket expenses incurred by households to gain access to a fixed basket of consumer goods and services.

The Analytical Living Cost Indexes (ALCIs) have been compiled and published by the ABS since June 2000 and quarterly since September 2009. They are produced as a by-product of the Consumer Price Index (CPI) and are the conceptually preferred measures for assessing the effect of changes in prices on the out-of-pocket living expenses experienced by four types of Australian households, based on the principal source of household income. These four household types account for just over 90% of Australian households. They are:
• employee households (i.e. those households whose principal source of income is from wages and salaries);
• Age Pensioner households (i.e. those households whose principal source of income is the age pension or veterans affairs pension);
• other government transfer recipient households (i.e. those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension) and,
• self-funded retiree households (i.e. those households whose principal source of income is superannuation or property income and where the HES defined reference person is ‘retired’ (not in the labour force and over 55 years of age).

The living cost indices, as released for the December quarter yesterday by the ABS are designed to answer the question:
‘By how much would after tax money incomes need to change to allow households to purchase the same quantity of consumer goods and services that they purchased in the base period?’

So what do the changes in CPI and ALCIs mean for older Australians.
Let’s use the ABS preferred yardstick of the ALCI.
And apply it to each of three relevant household groups; employee households (current wage/salary earners), Age Pension households (principle source of income age or veterans affairs pension) and self-funded retirees

Usually affected by changes in mortgage interest rates so hit hard last year, as shown in the ALCI – facing increases of 0.6% compared with CPI of +0.4%.
Age Pensioners
Pensions are indexed, according to the CPI or ALCI or median male earnings, whichever is greater. So to a certain extent those on pensions will be taken cared of regardless of the nature of the price increase. The index for age pensioner households rose 3/1% for the year to December, largely affected by increases in tobacco electricity, medical and hospital services, vegetables and insurance.
And self-funded retirees?
The ALCI shows an increase of just 2.6 per cent in living costs which is below the CPI of 2.7 per cent, so with frequent interest rate increases, self funded retirees are beginning to smile again!

And it’s important to note that floods did NOT affect collection of prices for the December 2010 – this will obviously change with the March 2011 quarter results.

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