Often, people track their real vs nominal income closely to understand their purchasing power in the best possible way.
Real Income is one such economic measure that offers the computation of an individual’s real purchasing power after estimating for inflation in the open Market. This measure subtracts the economic inflation rate from the real wage of an individual, resulting in a lesser value and reduced spending power.
Also, there are certain inflation measures that a person can use while calculating the real income. All in all, real income is just an estimate of the real wages of a person since the formula to calculate real income generally uses a wide collection of products that may or may not match the categories that a person spends on.
Also, companies might not spend the entire nominal income to avoid some of the effects of real income. Most of the businesses monitor the economic inflation rate closely to use it as a foundation for Investing in risk-free instruments.
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There are a few methods to calculate real income. Out of them, two basic real wage or real income formulas are:
Wages – (Wages x Inflation Rate) = Real Income
Wages / (1 + Inflation Rate) = Real Income
(1 – Inflation Rate) x Wages = Real Income
All of the real wage formulas can implement one of the many inflation measures. For consumers, three of the popular inflation measures are as follow:
The Consumer Price Index (CPI) is one measure that helps to evaluate the average cost of a certain basket of products, including medical care, transportation, clothing, recreation, education, and food and beverages.
The PCE Price Index is the second comparable price index that comprises a few different classifications of products and services. It also comes with its own methodology and adjustments nuances. Generally, it is used to evaluate the price inflation and while taking decisions on monetary policy.
The GDP Price Index is one of the widest inflation measures as it regards everything that is produced in an Economy.