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Economics/Incomes / cost of living


QUESTION: Michael Taillard,

I please ask you to picture a high cost of living city (maybe a capital city) versus a lower cost of living city. Generally incomes are higher in higher cost of living cities. People often earn more money.

Question: For two twin workers, with the exact same qualifications and skills, One works in a big city and the other one in a medium size city with a lower cost of living.They have the same job. Should the  one who lives in the big city make more money than the other one to compensate for the higher cost of living? Or, on the other hand, since they have the same skills, both should earn the same?

This is a topic I canīt seem to find an answer for. This is just an example to illustrate 2 possible scenarios.
Thank you

ANSWER: Whether this should be true or not is irrelevant, because what you describe is an inescapable reality.  It's all the result of geographic differentials in inflationary pressures.  As cities grow large, wages, prices, and costs all increase through a combination of cost-push inflation (rising costs associated with production) and demand-pull inflation (Aggregate Demand>Aggregate Supply).  The further from this localized area you go, the less influence that pocket of inflationary pressure will have on prices and wages.  As a rough calculation, the influence that one economic body places on another can be estimated using the equation X = G[(M1*M2)/D12]
Where, M1 is the economic mass of city 1, M2 is the economic mass of city 2, D12 is the distance between the two cities, and G is the same gravitational constant utilized in astrophysics.  This is the equation for trade gravity, estimating the amount of trade between two economic entities, but that extends also to inflationary pressures as increased trade results in other forms of economic counter-influence through the movement of capital, people, and factor price equalization between them.
This difference in inflation drives long-term trade cycles.  Whereas China's trade dominance for the last several decades has been driven by low wage costs, they're increased prices and costs (and, as a result, wages) are changing that as their average prices are increasing to equal the average prices in many other nations.  During the early 20th century, many Western nations fought in a currency war, wherein many nations were trying to strategically devalue their currencies to make their own exports more competitive (lower purchasing power in one currency makes that nations exports cheaper in terms of other currencies).  When people worry about jobs being shipped overseas, they only see it that way because all the jobs that are being sent away are those in major industrial regions where the majority of people live, so people don't see the jobs being shipped back to their own nation in rural, low-cost areas that people will only notice as the region develops into a new manufacturing base.
All this occurs naturally as a result of people and businesses attempting to maximize their efficiency through decreased costs and increased income.  That drives a nation to utilize its resources as efficiently as possible, generating the greatest amount of value utilizing a minimum of that nation's factors of production.  It's a good thing.

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QUESTION: Thanks for your fast answer.

I understand that some Jobs can benefit from a high income environment. I can imagine hairdressers, waiters, housekeepers and maybe other jobs with low skill requirements receiving more money in high income environments. These services are still needed whether you live in a high income city or not.

However, itīs hard for me to imagine a factory worker, a lawyer, a teacher, a banker, an engineer to get better paid, unless they can be more productive in a major city. That way, they would get more money because they add more value to society. High income cities must, therefore, benefit of some sort of synergies which can be maximized by these professionals. So, living in one of these cities wouldnīt be easy for everyone, just for some.

ANSWER: Don't forget that simply because something costs more or someone is earning more money in absolute terms does not mean that they are receiving more value in purchasing power.  Real wages for the majority of people around the world tend to remain stagnant.  So, just because someone is earning more money does not mean they're receiving more value in terms of good they can purchase.  Rather, the regional purchasing power of a currency decreases.
Also note that productivity does increase.  If averages wages in the US had increased proportionally with productivity gains over the past 50 years, the average American would be making $69,070 per year, instead of the current average of $45,000.  In cities this is particularly true because of the nature of the industries that drive city growth.  Whereas rural growth tends to be agriculturally-based, and our ability to grow food per acre of land is relatively fixed, advances in systems, labor, and technology in the secondary and tertiary economic sectors (industry and services, respectively)do not have such limitations.  As a result, globally we see production gains outpacing population growth rates, which means that we are more productive per person than we used to be.
On top of that, the gains through increased efficiency that result from shifting manufacturing jobs to areas of low-labor costs increase producer surpluses as prices remain stagnant, meaning that companies and the people who own and manage those companies have more discretionary income, and more taxable income, both of which fund the higher wages in that region - wages that are necessarily higher in order to attract the labor force to jobs in a region with higher cost of living.  If wages don't meet a minimum level appropriate for the regional cost of living, then no one will take those jobs.  Since there is demand for labor, wages need to increase to attract workers.  That's the nature of outsourcing - its a selection process whereby people decide whether its worth keeping products/services local or send them to a distant location (domestic or foreign), balancing the need for cost-savings and local responsiveness.

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QUESTION: So your view is that workers getting better paid isnīt a result of their higher value/ productivity but a result of the higher cost of living they have to support?

It's not a view, it's a fact.
Real wages remain stagnant:

While GDP per capita increases:

While wages for a select few increase at a higher rate than productivity gains:

And ROI increases for capital ownership.

Productivity gains do not translate into increases in income.  Increases in income are taken when workers begin to refuse employment as a result of wages that are too low.  Until that happens, productivity gains translate only into increases in returns on investment for business and capital owners, increasing real income for only about 2% of the population.


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Michael Taillard


Accepts most economic questions


Consulting with major corporations, government agencies, political organizations, small businesses, non-profits, start-ups, and even individual people. Teaching at universities around the world, and developing original coursework. Performing original research and analysis. Writing books and scientific studies.

American Economics Association

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PhD (Financial Economics; honors) -- MBA (International Business Finance; honors) -- Grad School Certificate (International Business Management; honors) -- BS (International Business Economics; honors) -- AA (Business Administration; honors) -- Certificate (Chinese Language and Culture) -- Trade School (Transportation Logistics; honors)

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