Real Terms

When we’re talking money, it’s important to distinguish: are we talking in nominal terms, or real terms?

A nominal amount of money is money at its face value. A dollar is a dollar is a dollar.

Real amounts of money are what that money can buy, rather than its face value. A dollar in 1950 could buy you four gallons of gas. As of this writing, one dollar could buy you about one third of a gallon of gas, based on the U.S. national average gas price.

Because prices and wages generally inflate...meaning it takes more money to buy the same amount of goods as before...the purchasing power of money goes down over time. A dollar just can’t buy you nearly as much today as in ye olden days.
All this “real” and “nominal” talk applies to all things money: prices, wages, savings, exchange rates, you name it. Nominal refers to the numbers we’re used to working with as consumers, but the real value of money is necessary when comparing costs over time.

For instance, if you get a raise, you’re probably feeling yayyyyy Inside. Not to burst your balloon, but you’ll have to convert that to see if you actually got a raise in real terms. In other words, did your nominal raise just catch you up with inflation, or did it actually increase your ability to buy more stuff? If you got a 10% raise, but inflation (prices) rose 10% over that time period, then you have the same real income as before. Your real income was eroding over time, since it was staying the same nominally as prices rose. Prices went up 10%, and so did your nominal income. Which means your real income went up a whopping 0%.

If, however, you got a 10% raise, but inflation only went up 4%, then you got an 6% raise in real terms. You have 6% more purchasing power than you did before. Now that’s what we’re talking about. More money for new clothes, or maybe a new at-home gym set, or...maybe savings for retirement. Eh, clothes are more fun.