What is real income?

Real income is an indicator that shows purchasing power taking inflation into account. It therefore describes the amount of goods that can be purchased on the market with the nominal income.

In this lesson we explain the meaning of real income and the real wage index and how they are calculated. Following this lesson, we will provide you with a few practice questions to check your knowledge.

  • Synonyms: Real wage | Real wage index
  • English: Real wages

Why should you know real income?

According to whicheverhealth, real income is an important economic indicator for measuring purchasing power. Changes in real wages indicate when the purchasing power of employees changes. The real wage is therefore a decisive factor for both employees and companies.

Significance and calculation of real wages

In economics, real wages measure the relationship between nominal wages and price levels. Real income always increases when the nominal wage rises faster than the price of goods. If the increase in the nominal wage lags behind that of the price of goods, the real wage falls, as the purchasing power of employees decreases.

The nominal wage on which real income is based is defined as an average value. Both the net wage after taxes and social security contributions and the gross wage can be used. If the net wage is used as the basis for calculating, changes in real wages have a corresponding effect on the purchasing power of employees. If, on the other hand, the gross wage is decisive, changes in real wages show whether, from the point of view of the company, working in an economy is becoming more expensive or cheaper.

real income

Real income: Development of real wages, nominal wages & consumer prices in Germany

Formula: Calculation of real income

The real wage is calculated from the relationship between the wage rate and the price level.

The formula is therefore:

  • The factor W comes from the English term “wages” and in this formula represents the aggregated nominal wage. This is the average gross hourly wage measured in monetary units.
  • The factor P stands for the average price of the goods.

For consumers, the real wages are always decisive and not the nominal wage, since the decisive factor for them is how many goods and services they can actually acquire from wages. Real wages can therefore also be referred to as wages in the form of units of goods. Real wages are also decisive for companies, as the relationship between the nominal wage and the price of the finished product is relevant to them.

Real wage index

The real wage index is formed from the quotient of the nominal wage index and the consumer price index. In Germany, the real wage index is regularly determined by the Federal Statistical Office. If the real wage index changes, this corresponds roughly to the change in the nominal wage minus the inflation rate.

 

About the author