Real income
Encyclopedia
Real income is the income
of individuals or nations after adjusting for inflation
. It is calculated by subtracting inflation from the nominal income. Real variables, such as real income, real GDP
, and real interest rate
are variables that are measured in physical units, while nominal variables such as nominal income, nominal GDP, and nominal interest rate
are measured in monetary units. Therefore, real income is a more useful indicator of well-being, since it is based on the amount of goods and services that can be purchased with the income. According to the classical dichotomy theory
, real variables and nominal variables are separate in the long-run
, meaning they are not influenced by each other. In other words if the nominal starting income was 100 and there was a 10% inflation (general rise in prices eg: what cost 10 now costs 11) rate. So now with 100 you can buy less and if your income is not adjusted by inflation (did not rise by 10%),your real income has dropped 10%.
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
of individuals or nations after adjusting for inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. It is calculated by subtracting inflation from the nominal income. Real variables, such as real income, real GDP
Real GDP
Real Gross Domestic Product is a macroeconomic measure of the value of output economy adjusted for price changes . The adjustment transforms the money-value measure, called nominal GDP, into an index for quantity of total output...
, and real interest rate
Real interest rate
The "real interest rate" is the rate of interest an investor expects to receive after allowing for inflation. It can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate...
are variables that are measured in physical units, while nominal variables such as nominal income, nominal GDP, and nominal interest rate
Nominal interest rate
In finance and economics nominal interest rate or nominal rate of interest refers to the rate of interest before adjustment for inflation ; or, for interest rates "as stated" without adjustment for the full effect of compounding...
are measured in monetary units. Therefore, real income is a more useful indicator of well-being, since it is based on the amount of goods and services that can be purchased with the income. According to the classical dichotomy theory
Classical dichotomy
In macroeconomics, the classical dichotomy refers to an idea attributed to classical and pre-Keynesian economics that real and nominal variables can be analyzed separately...
, real variables and nominal variables are separate in the long-run
Long-run
In macroeconomics, the long run is the conceptual time period in which there are no fixed factors of production as to changing the output level by changing the capital stock or by entering or leaving an industry. The long run contrasts with the short run, in which some factors are variable and...
, meaning they are not influenced by each other. In other words if the nominal starting income was 100 and there was a 10% inflation (general rise in prices eg: what cost 10 now costs 11) rate. So now with 100 you can buy less and if your income is not adjusted by inflation (did not rise by 10%),your real income has dropped 10%.