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Macroeconomics
Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.
Unemployment and Inflation
Nominal Income and Real Income
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Nominal Income and Real Income
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So just like we can talk about nominal interest and real interest, we can discuss nominal income and real income. So just like with interest the difference between the nominal and the real is gonna have to deal with inflation here. So when we're discussing nominal income, nominal income is gonna be the actual number of dollars you receive. So when you go to work and they pay you your salary $10 an hour. Well that $10 an hour is your nominal income right? The number of dollars received as wages or salary rent could be profit. So whatever type of income you have. Right? So if you just have a job we're talking about wages or salary. But if you're a landlord rent any of this is nominal income. So when we talk about real income while we're adjusting that nominal nominal income for inflation so it's adjusted for inflation. Okay so remember how inflation affects our income is the same way it affects interest. Is that it's going to make our purchasing power less right? Real income it's going to measure the amount of goods you can buy. So if you're thinking about what you could buy in one year and what you could buy in another year, well that would have to deal with your real income, your purchasing power of that money. Okay so let's go ahead and use a calculation for real income. It's we're gonna take our nominal income what we can uh what we're earning and we're gonna divide it by the price index. So this is the C. P. I. When we're talking about the price index, we're talking about the C. P. I. Here and notice that it's in hundreds. So we're going to have to if they give you the C. P. I. As say like um 100 and 10. Well we would have to move that. So C. P. I. Of 100 and 10. We would have to move it and do it 1.10. Okay. We will be dealing with as more of a decimal rather than a percentage there. So what what would that what would that C. P. I. Of 1 10 mean that those prices are 1.1, the level of what they were in the base year. So the base year would have had a cp of 100 and now it's 1 10. That means we've increased by essentially 10% there since the base year. Okay. So if nominal income increases at the same rate as the price index then what happens to the real income, we'll think about it. If your nominal income is increasing the price level is increasing at the same rate, well the real income is gonna stay constant because what's happening is if you're earning more money, hey you're getting a raise from $10 to $12 you've gotten a 20% raise. But if at the same time the price of everything goes up by 20% which is what it's saying here if nominal income your $10 wage going to $12 increases at the same right as the price index. The price, the prices of everything also went up by 20%. Well, you can purchase just the same as before, right? Because your real income is gonna stay the same there. Alright. So, in essence, these are the main formulas. You're gonna want to know here how to calculate real income is just taking the nominal income divided by the price index. And then we're also going to be able to calculate the change in your real income by by noticing the change in the nominal income and the change in the price level. So, we've got an example that we're going to practice using these formulas. Let's do that in the next video.
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example
Nominal Income and Real Income
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Alright let's try this example DJ. Money faces the world's best DJ in 2017. He earned $20,000 playing the most popular music at nightclubs. He spent many nights practicing twisting knobs and holding one earphone 11 of the headphones to his ear audiences were so thrilled by his itunes playlist that in 2018 he was able to earn $25,000 selecting the most popular music. Use the following information regarding C. P. I. To answer these questions. So we're gonna go through a together, we're gonna calculate D. J. Money faces real income in 2017 and we'll take a pause. I want you guys to try and calculate the 2018 income and also use that percentage change formula to calculate the percentage change in his real income. Alright so let's go ahead. We're gonna start here with a together and then you guys can try the other ones. So let's start with a his 2017 real income. So remember when we're calculating real income we just want to take the nominal and we're gonna divide it by the price index, the C. P. I. And we're gonna do it in hundreds right in hundreds. So as a decimal. So let's go ahead and do this here. So what was his nominal income in 2017? We have it right up here in 2017. He earned $20,000. So his the numerator here is gonna be 20,000 and we'll divide it by the C. P. I. In what year we're gonna use the C. P. I. From 2017 right in 2017. the C. P. I. Was 118. So we got to convert that to a decimal. So 1 18 that's like 100 and 18% of the base year prices. So it's gone up by 18%. So we're going to convert it to 1.18. We move the decimal over two times and now we've got um a decimal instead of a percent. So we're gonna divide by 1.18 here And we'll do the equal sign right down here. So in 2017 what is his real income? So let's see what that is. Come on calculator. Don't feel me now. Alright 20,000 divided by 1.18. It gives us a real income of 16,000 $949.15. Okay $16,949.15. That is his real income in 2017. So what does that mean? What does it mean that that's his real income? That means if we compared it to the base year in 2005 notice 2005 is our base year here. They didn't tell us but we can we can gauge that it's the base year because it's 100 in 2005. Um So the price level was uh what we're saying is that if this money was earned in 2005 it was worth $16,949.15. So what he earned the 20,000. This is a better explanation. The 20,000 that he earned in 2017 Would have been the equivalent of earning $16,949 in 2005. Okay, so basically the same purchasing power, right? He's able to purchase the same amount of goods because inflation has taken place since 2005. Alright, let's take a pause here, and you guys try to solve the real income in 2018, and then we'll do another video for the final one. question seat. Cool.
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Nominal Income and Real Income
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Alright, let's see how you guys did with the 2018 real income. So in 2018 his real income, we're gonna take his nominal income in 2018, which was 2018. He was able to earn $25,000 and we'll divide that by the C. P. I. And which C. P. I. Are we gonna use The 2018 c. P. I. Right 2018. And that was 1.20. So 1.20 is our denominator here. Let's go ahead and calculate 25,000 Divided by 1.20. It's gonna give us a nominal or real income. Excuse me, real income of 20,000 8 33 and 33 cents. Okay, so now what we're talking about is if we had in in 2018 he earned $20,833.33 in 2005 money. Right? It has the same purchasing power as in the base year, $20,833 of purchasing power. Cool. Alright. Let's pause here and then let's try question. See in the next video
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Nominal Income and Real Income
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Alright now let's calculate the percentage change in D. J. Money faces real income. Now there's two ways we can go about this we can find the percentage change. So if we go above remember the percentage change in real income? Well that's the percentage change in nominal income minus the percentage change in the price level. And that will approximate the percentage change in real income. But we've already calculated the real income. Right? So remember anytime we're doing percentage change it's just new minus old divided by whoops divided by old new minus old divided by old. Right? That's how we do percentage change formulas. So I'll go through both of them just so you see that we get approximately the same answer to to two decimal places here. So let's go ahead and do um let's start by just taking the real income and finding the percentage change between our our real incomes. So percentage change in real income. So we would take the new which was 83 20,003 830.33 minus the old which was 16 949.15 right? The 2018 minus 2017 real income and divided by the old. 9 16,049 90.15. Okay so what's that gonna give us here If we do this math 20008 3 3.33 -16949 .15. And we divide that by 16 949.15. And it gives us approximately 0.230 point 23. And that's as a um As a decimal so that equals 23% when we calculate it that way. Now let's calculate it the other way where we're gonna take the percentage change. So remember in our formula we had the percentage change in real income I'll put our eye for real income is equal to the percentage change in nominal income minus the percentage change in CPI I write the price level. Okay so Instead of if we hadn't calculated the real income already we could have just taken the nominal income and the price level and found the percentage change in each of those. So let's go ahead and do that. Let's start with the nominal income. And the nominal income was 25,000 In 2018. 20,000 in 2017. And we'll put 20,000 in the denominator right? New minus old, divided by old and we'll subtract from that. This percentage change in CPI I so C p I was 1 2020 18 1 18 in 2017 and divided by 1 18. Right New minus old divided by old. So let's get each of these numbers. So let's do 25,000 minus 20,000 divided by 20,000. That gives us 0.25. And what about the other one? 1 20 minus 1 18 divided by 1 18. Whoops. Let me try that again. 1 20 minus 1 18, divided by 1 18. It gives us zero point 017 will round it to their. And what does that give us? So the percentage change in real income would be the difference of these two which is equal to 20.25 minus point oh 17. It comes out 2.233. So again this is an approximation this is like when we had our fishery equation and we got an approximation here. Same thing going on here. But it to a certain extent gets us approximately to the correct answer right? 23% as well. So that's uh the easy way to do it. Let me get out of the way when we have just the nominal and the C. P. I. So if they had given you the percentage change in the nominal income and the percentage change in CPI I well you would know just to subtract the two just like in our equation if they had just given you those percentage changes in a multiple choice for example. Well you would just subtract them to get an approximate for the percentage change in real income. Cool. Alright. So a bit of math there but nothing too crazy. Just a percentage change formula. And putting it to work. All right. So that's how we calculate real income. Let's go ahead and move on to the next video
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