Real income is the income of
individuals or
nations after adjusting for
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
. It is
calculated by dividing
nominal income by the
price level.
Real variables such as real income and
real GDP are
variables that are
measured
Measurement is the quantification of attributes of an object or event, which can be used to compare with other objects or events.
In other words, measurement is a process of determining how large or small a physical quantity is as compared t ...
in
physical units, while
nominal variables such as
nominal income
Nominal may refer to:
Linguistics and grammar
* Nominal (linguistics), one of the parts of speech
* Nominal, the adjectival form of "noun", as in "nominal agreement" (= "noun agreement")
* Nominal sentence, a sentence without a finite verb
* Nou ...
and
nominal GDP are measured in
monetary units. Therefore, real income is a more useful
indicator of
well-being
Well-being, or wellbeing, also known as wellness, prudential value or quality of life, refers to what is intrinsically valuable relative ''to'' someone. So the well-being of a person is what is ultimately good ''for'' this person, what is in t ...
since it measures 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, so they are not influenced by each other. In other words, if the nominal starting income was 100 and there was 10% inflation (general rise in prices, for example, what cost 10 now costs 11), then with nominal income of still 100, one can buy roughly 9% less; so if nominal income was not adjusted for inflation (did not rise by 10%), real income has dropped by approximately 9%.
But if the classical dichotomy holds, nominal income will eventually go up by 10%, leaving real income unchanged from its original value.
References
Household income
{{income-stub