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Real income adjusts for inflation and is based on tangible goods or services that money can buy. Inflation decreases the value of money over time, but a certain level of inflation can stimulate economic growth. Actual income is preferred for measuring income and comparing income levels over time.
Real income is adjusted for inflation. It is contrasted with nominal income, which does not take into account the effects of inflation. Real income is based on the tangible goods or services, such as milk or bread, that money can buy. In macroeconomic calculations, it is often the preferred method of measuring changes in income over time or between different countries.
Inflation is a decrease in the value of a given amount of money over time. Most economists agree that inflation in the long run is the result of an increase in the money supply, for example, when a government prints more bills. This relationship between the total quantity of money and prices is called the quantity theory of money. British economist John Maynard Keynes, on the other hand, argued that inflation was also affected by factors such as the level of private spending. In any case, the effects of inflation are an important part of economic and financial decisions.
Although inflation reduces the amount of goods and services that one amount of money can buy, most economists agree that a certain level of inflation has an overall positive effect on the economy. It encourages people and businesses to spend money now instead of later, which stimulates economic growth. Without inflation, money would be worth more in the future; People would be encouraged to hoard their money rather than spend it.
If the inflation rate were 5%, a person’s nominal income of $30,000 US dollars (USD) would have to increase by 5% each year to maintain a stable real income. Any nominal income less than $31,500 USD the following year would constitute a reduction in actual income. Real income can be calculated by taking nominal income and subtracting the annual inflation rate.
Actual income is the preferred method of measuring income in a variety of different circumstances. It could be helpful when evaluating the potential for future raises at a job. If an employer promised a 2% salary increase every year, but the inflation rate stayed at 3%, it would not be a good deal. This would mean that real income would fall by 1% each year, rather than rise at all. The employee could buy fewer real world goods each year in this situation.
Researchers often use real income when calculating general trends in an economy. An actual income figure is much more useful when comparing income levels from different times in history. The median salary in the United States in 1960, for example, was $4,007.12 (USD). It’s hard to imagine if this is high or low if you don’t know how much this money could have bought in 1960.
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