Real Income

We’re not saying your income isn’t real...we’re just saying it’s nominal.

Your paycheck every month is in nominal dollars, i.e. just the dollar amount. If that’s the case, what’s your real income? The truthful income?

Your income is only as good as prices. If you make $8 per hour and the average burger costs $8, you can have a burger per hour you work. However, if burger prices double to $16 per burger, now you can only get half a burger per hour you work. Now your boss gives you a raise to $16. You feel a sense of joy and pride. Think of all the things you could buy. Well, tough luck, because you didn’t get a real raise, just a nominal raise. Now you’re back where you started: you can by one burger for every hour you worked.

When prices and income go up, it’s because of inflation. To get your real income, we have to calculate out the inflation part. That leaves us with a sense of what the money can actually buy...what we call “purchasing power.”

In the example above, your nominal income rose from $8 per hour to $16 per hour. Your nominal income doubled. But, if prices doubled during that time period too, then your real income didn’t rise at all. Your real income stayed the same.
Next time you get a raise, take a look at your country’s inflation rates to see if your real income (your purchasing power) actually went up too (or not).

Another thing to keep in mind: prices don’t all rise at the same rates. For instance, in the U.S., the real cost of college has gotten increasingly expensive compared to other baskets of goods, like rent, food, and transportation costs. Which means that, when your mom tells you she was working a part-time job paying for college, you can tell her college is more expensive now than it was then...and not just nominally, i.e. not just because of inflation. It’s actually more expensive in real terms.

Check out the Consumer Price Index published by the Bureau of Labor Statistics to see this in action. It tracks the real costs of baskets of goods over time. Oh, and look up your raises and inflation, to make sure you’re real income isn’t going down too much.