30/12/2021
✓✓ What Is Real Income?
Real income is how much money an individual or entity makes after accounting for inflation and is sometimes called real wage when referring to an individual's income. Individuals often closely track their nominal vs. real income to have the best understanding of their purchasing power.
Real income is an economic measure that provides an estimation of an individual’s actual purchasing power in the open market after accounting for inflation. It subtracts an economic inflation rate per dollar from an individual’s income, typically resulting in a lower value and decreased spending power.
Real income differs from nominal income, which is not adjusted to account for fluctuating prices and living costs. Individuals often closely track their nominal vs. real income to have the best understanding of their purchasing power.
Overall, real income is only an estimate of an individual’s purchasing power since the formula for calculating real income uses a broad collection of goods that may or may not closely match the categories an investor spends within. Moreover, entities may not spend all of their nominal income, avoiding some of the real income’s effects.
✓✓ Real Income Formula
There are several ways to calculate real income. Three basic real income formulas include the following:
1. Wages - (wages * inflation rate) = real income
2. Wages / (1 + Inflation Rate) = real income
3. (1 – Inflation Rate) * Wages = real income
✓✓ Mathematical illustration with one of the above formula
Now assuming a wage is $2000
Inflation rate is 14% ~ 0.14
Real income = ?
Using formula (1)
$2000 - ($2000 * 0.14) = $1720
$1720 is the real income/ purchasing power of the individual.
