The real and nominal income are calculated respectively at constant prices and current prices. This distinction helps economists and individuals understand the true purchasing power of money over time.
While nominal income measures earnings in monetary terms at current market prices, real income adjusts these earnings to reflect changes in inflation. It gives a clearer picture of actual economic well-being.
What Is Nominal Income?
Nominal income refers to the total income an individual or entity earns in a given period, measured using the current prices of goods and services.
It does not take inflation or deflation into account. In simpler terms, it shows how much money you receive without considering how much that money can actually buy.
What Is Real Income?
Real income represents the income adjusted for inflation. It shows the actual purchasing power of the earned money. This means it reflects how many goods and services can be bought with the income after accounting for the rise in prices.
For instance, in a real income example, if your salary rises by 10% but prices also rise by 8%, your real income has increased by only 2%. This calculation helps assess the true improvement in living standards.
How Are They Calculated?
- Nominal income is calculated at current market prices, which vary year to year.
- Real income is calculated at constant prices, using a base year to remove the effect of inflation.
Thus, real and nominal income are calculated, respectively, at constant and current prices, and they provide a comparative measure of economic growth and purchasing power over time.
