Real income

Real income is the amount of money that an individual or family has to spend after taking into account the effects of inflation. It is calculated by subtracting the inflation rate from the nominal income. Real income is a more accurate measure of an individual or family's purchasing power than nominal income, as it allows for the effects of inflation.

For example, if a family has a nominal income of $100 and inflation is 5%, then their real income would be $95. This means that, after adjusting for inflation, the family has $95 to spend on goods and services.

Real income can also be used to measure economic growth. It can be calculated by taking the nominal gross domestic product (GDP) and subtracting the inflation rate. This figure shows the real economic output of the country and can be used to compare economic performance over time.

Example of Real income

Real income is a more accurate measure of an individual or family's purchasing power than nominal income. By subtracting the inflation rate from the nominal income, real income can be calculated.

The following are examples of real income:

• Real wages: This is the money that an individual earns after taking into account the effects of inflation.
• Real disposable income: This is the money that an individual has to spend after taking into account the effects of inflation.
• Real GDP: This is the economic output of a country after adjusting for inflation.

Formula of Real income

The formula for calculating real income is: Real Income = Nominal Income - Inflation Rate.

When to use Real income

Real income is used in a variety of contexts, including to measure an individual or family's purchasing power and to measure economic growth.

• To measure an individual or family's purchasing power: Real income is the best measure of an individual or family's purchasing power, as it allows for the effects of inflation. It is calculated by subtracting the inflation rate from the nominal income.
• To measure economic growth: Real income can be used to measure economic growth by calculating the real GDP, which is the nominal GDP minus the inflation rate. This figure provides a more accurate measure of economic performance than the nominal GDP.

Types of Real income

• Disposable Income: Disposable income is the amount of money that a person has available to spend after all taxes and other deductions have been taken into account. It is calculated by subtracting taxes and other deductions from the person's gross income. Disposable income is an important measure of an individual's economic well-being, as it shows the amount of money that is actually available to be spent.
• Discretionary Income: Discretionary income is the amount of money that an individual has available to spend after all essential expenses have been paid. It is calculated by subtracting essential expenses, such as housing, food, and transportation, from the individual's disposable income. Discretionary income provides an indication of an individual's financial freedom, as it shows the amount of money that is available to be spent on non-essential items.
• Saving: Saving is the amount of money that an individual has available to put aside for future use. It is calculated by subtracting the individual's total spending from their total income. Savings are important for an individual's financial security, as they provide a cushion in the event of an emergency or an unexpected expense.

Steps of Real income

1. Calculate the nominal income of an individual or family: The nominal income is the gross income before any taxes or deductions.
2. Calculate the inflation rate: This can be done by comparing the prices of goods and services from year to year.
3. Subtract the inflation rate from the nominal income: This will give you the real income, which is a more accurate measure of an individual or family's purchasing power.
4. Calculate the real GDP: This can be done by taking the nominal GDP and subtracting the inflation rate. This figure will show the real economic output of the country.

Advantages of Real income

• Real income provides a more accurate measure of an individual or family's purchasing power: By taking into account the effects of inflation, real income allows for a more accurate assessment of an individual or family's purchasing power.
• Real income can be used to measure economic growth: By subtracting the inflation rate from the nominal GDP, real income can be used to measure economic growth and compare economic performance over time.
• Real income can be used to compare economic performance between countries: By using the same measure of real income, it is possible to compare economic performance between different countries.

Limitations of Real income

Real income has several limitations that should be taken into account when using it as a measure of economic performance.

• It does not take into account changes in the cost of living, as it only adjusts for the effects of inflation.
• It does not take into account population growth, which can affect economic growth.
• It does not account for changes in the quality of goods, as it assumes that the quality of a good or service remains constant over time.
• It does not take into account changes in economic structure, as it assumes that the structure of the economy remains constant over time.

Other approaches related to Real income

• Sustained Real Income: Sustained real income is a measure of the average change in real income over a period of time. This approach accounts for the effects of inflation and the changing cost of goods and services. It is calculated by taking the nominal income and adjusting it for inflation, then comparing it to the same income figure in the previous period.
• Real Wage: Real wage is the purchasing power of a person's wages after taking into account the effects of inflation. It is calculated by subtracting the inflation rate from the nominal wage. This figure allows for a more accurate comparison of wages over time and across countries, as it takes into account the changing cost of goods and services.
• Cost of Living Adjustment (COLA): Cost of living adjustment is a measure of the change in the cost of goods and services over time. It is calculated by subtracting the inflation rate from the nominal cost of goods and services. This figure can be used to compare the cost of living across countries and over time, as it allows for the effects of inflation.

To summarize, there are several approaches related to real income that account for the effects of inflation. These include sustained real income, which takes into account the average change in real income over time, real wage, which is the purchasing power of a person's wages after adjusting for inflation, and cost of living adjustment, which measures the change in the cost of goods and services over time.

Real income — recommended articles

National income measures — Net domestic product — GDP deflator — Constant price GDP — Consumer price index — Average annual growth rate — Wholesale price index — Nominal income — Value of money over time

References

• Dharmapala D. (2012), What Do We Know About Base Erosion and Profit Shifting? A Review of the Empirical Literature, CESifo Working Paper, nr 4612, p. 30-36
• Le Maire D., Schjerning B. (2012), Tax Bunching, Income Shifting and Self-employment, EPRU Working Paper Series, nr 2012-04, p. 7-10
• Lohse T., Riedel N. (2014), Do transfer pricing laws limit international Income Shifting? Evidence from European multinationals, CESifo Working Paper, nr 4404, p. 3-6