Larry DeBoer
Professor of
Agricultural Economics
Purdue University

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States and the Cost of Living

Indiana's income per person ranks 39th among the states. Many people respond, "Yes, but isn't our cost of living lower? Doesn't a dollar in Indiana buy more than a dollar in New York or California?" Unfortunately, data comparing the cost of living among the states couldn't be had—at least not from official sources.

Until now.

This past spring, the Bureau of Economic Analysis, a branch of the U.S. Department of Commerce, released their "regional price parities." It's the first time the department has measured the differences in the cost of living among states. The traditional price indexes (like the consumer price index) compare prices year to year for the entire country.

The RPPs measure prices in each state as a percentage of the national average. Indiana's RPP for 2012 is 91.1, which means that, on average, prices here are 8.9 percent less than average prices in the whole U.S. You can see the numbers in the state and local income section of the BEA's website.

So, as we always suspected, Indiana's cost of living is less than the national average, 16th lowest in the U.S. When we adjust Indiana's 39th-ranked income per person for cost of living, our real income is 31st highest. That's still below average but, unfortunately, not by as much.

Some states with high costs of living have such high incomes that they're still near the top after the cost of living adjustment. Connecticut's 2nd-ranked per capita income ranks 3rd after accounting for its high prices. Likewise, some states have incomes so low that even low prices can't compensate. Mississippi has the lowest cost of living in the U.S., but its income per person still ranks 44th in the nation, even after accounting for those low prices.

Hawaii has the 21st highest per capita income, but after adjusting for the state's very high cost of living, real income ranks 47th. Hawaii is actually one of the lowest income states in the U.S. Of course, people who live in Hawaii get to live in Hawaii! Maybe that's worth a lower income.

California is similar. Its income per person is 13th highest, but after adjusting for prices California ranks 34th. That's right—the average Californian's income is less than average income in Indiana, after adjusting for cost of living.

Why do some states have higher prices than others? We can get a clue from the components of the regional price parities. The BEA reports RPPs for goods, rents and other services. The index for goods ranges from 92.8 in Missouri to 108.1 in New York. Goods prices are 16 percent higher in New York than they are in Missouri. Other service prices are 28 percent higher in New Jersey than they are in (once again) Missouri. But rents in Hawaii are 156 percent higher than in Mississippi. There's far more variation in housing costs than in other categories.

The rent RPP differs so much across states that it's the main source of variation in the overall parities. Some of the variation in prices for goods, prices and other services probably reflect rents, too. A chain restaurant in New York City will have to charge higher prices than the same restaurant in Redkey, Indiana, to cover the higher rent.

But why the variation in rents? Well, rent is a price. Ask an economist about price, and the first words out of his or her mouth are "supply and demand." There's only so much land in Manhattan or LA. A lot of people want to live and do business in those places. Limited supply and high demand bid up rents for land and buildings. West Lafayette, Indiana, is surrounded by land that could be developed—even though it's really excellent for growing corn—but not as many people want to live here as in New York. Go figure. So rents don't get bid upward. Sure enough, there's a pretty substantial correlation between the share of a state's population in cities and its cost of living index.

The cost of living is high in some places and lower in others, according to the regional price parities. But with this new index, the cost of finding out about those differences just got a lot lower.




Writer: Larry DeBoer
Editor: Olivia Maddox