Deflating Cost of Living Index (C.L.I.) Numbers

The cost of living index (C.L.I.) is a measure of the relative cost of living in different geographical areas, typically determined by calculating the aggregate cost of a basket of goods and services in each location. However, these raw numbers do not necessarily reflect the true purchasing power of individuals in each area, as they do not take into account differences in wages or inflation rates. To account for these factors, analysts often use a process called deflation to adjust the C.L.I. numbers.

Deflation involves dividing the C.L.I. number for a given location by the corresponding inflation rate, which yields a real cost of living index (R.C.L.I.) number. This R.C.L.I. number represents the true cost of living in that location, adjusted for the effects of inflation. By comparing R.C.L.I. numbers across different locations, analysts can determine the relative purchasing power of individuals in each area.

Using Deflated C.L.I. Numbers to Find Real Wages

Once R.C.L.I. numbers have been calculated for different locations, they can be used to determine real wages. Real wages are wages adjusted for inflation, meaning they reflect the actual purchasing power of an individual's income. To calculate real wages, analysts divide a worker's nominal wage (the wage stated in current dollars) by the R.C.L.I. number for their location. The resulting number represents the worker's real wage, or the amount of goods and services they can actually purchase with their income.

For example, suppose a worker in New York City earns a nominal wage of $20 per hour, and the R.C.L.I. for New York City is 1.05. To calculate their real wage, we would divide $20 by 1.05, yielding a real wage of $19.05 per hour. This means that the worker can purchase $19.05 worth of goods and services for every hour worked, after accounting for the effects of inflation and the relative cost of living in their location.

A) deflating of index number