1. If people's incomes rise by 4% but prices rise by 6%, people's real income 2. If people's incomes rise by 5% but prices rise by 3%, people's real income

Question

1. If people's incomes rise by 4% but prices rise by 6%, people's real income 2. If people's incomes rise by 5% but prices rise by 3%, people's real income

Answer 1

Hi Rayyan, people's nominal income is usually indexed to inflation. This means that people's income usually increase as the general price level in the economy increases over time. Real wage (W/P) or real income is nominal income (W) divided by the price level (P). A person' real income is a measure of his/her purchasing power.

1. If prices increase faster than the increase in nominal income, then people's real income falls. In the first part of the question, when people's income increase by 4% but prices rise by 6%, people's real income actually falls by 4% - 6% = 2%. Thus, the purchasing power of individuals fall by 2%. Inflation makes people worse off.
2. If people's income increase by 5% but prices rise by 3%, people's real income actually increases by 5% - 3% = 2%. Thus, the purchasing power of individuals increases by 2%. In this case, even though prices increase by 3%, since nominal income increases faster (5%) than prices, people are actually made better off.

Answer 2

Hi Rayyan,

It seems like there could be a number of solutions to this but generally:

1. If people's incomes rise by 4% but prices rise by 6%, people's real income decreases/does not change. If prices are rising faster than income is rising, the increase people's income could just be due to inflation.
2. If people's incomes rise by 5% but prices rise by 3%, people's real income increases. If people's income is rising faster than prices, this indicates that the change people's income could be due to more than just inflation.