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Chapter 4: Problem 132

What is the difference between money income and real income?

Short Answer

Expert verified
The difference between money income and real income lies in how they measure the purchasing power of individuals. Money income refers to the total amount of income an individual receives during a specific period in units of currency and includes wages, salaries, and other income sources. Real income, on the other hand, is the amount of goods and services that can be purchased with the money income after adjusting for inflation, effectively measuring an individual's purchasing power. Comparing both is crucial to determine the actual purchasing power of an individual or an economy over time. For example, if an individual receives a 10% increase in money income and the inflation rate is 8%, their real income increase would be approximately 1.85%, indicating that their purchasing power increased by a small margin.

Step by step solution

01

Definition of Money Income

Money income refers to the total amount of income an individual receives during a specific period, usually calculated in units of currency like dollars, euros, etc. It includes wages, salaries, and other sources of income, such as investments and rental income.
02

Definition of Real Income

Real income is the amount of goods and services that can be purchased with the money income after adjusting for inflation. The real income takes into account changes in the price level, so it effectively measures an individual's purchasing power.
03

Importance of Comparing Money and Real Income

Comparing money and real income is important to determine the actual purchasing power of an individual or an economy over time. Money income can give the illusion of more wealth due to inflation, which devalues currency over time, but real income considers inflation to provide a more accurate picture of a person's financial well-being.
04

Example: Money Income vs Real Income

Let’s use an example to illustrate the difference between money and real income. Imagine an individual receives a 10% increase in money income. However, if the inflation rate during the same period is 8%, the purchasing power of the individual hasn't increased by 10%. To calculate the real income increase, we need to remove the effects of inflation: Real Income percentage increase = \( \frac{(1 + 0.1)}{(1 + 0.08)} - 1 = 0.0185 \), or approximately 1.85%. In conclusion, although the money income increased by 10%, after considering the inflation, the real income increased by only 1.85%, meaning that the individual's purchasing power only increased by a small margin.

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Most popular questions from this chapter

In January 1979, Mr. John sold his 1973 Ford to Mr. Daniel. One month later, Mr. John purchased a brand new Ford which he resold a week later to Mr. Smith. Which of the transactions would be included in the computation of 1979 GNP? Defend your position.

There are basically two approaches to GNP: the expenditure approach and the income approach. The following is a list of national income figures for a given year. Arrange them in the form of a consolidated income statement with revenues and allocations ( expenses ') for the whole of the economy. The figures are in billions of dollars. \(\begin{array}{lr}\text { Personal consumption expenditures (C) } & 660 \\\ \text { Transfer payments } & 127 \\ \text { Rents } & 40 \\ \text { Capital consumption allowance (depreciation) (D) } & 95 \\ \text { Social security taxes } & 46 \\ \text { Interest } & 20 \\ \text { Proprietor's income } & 68 \\ \text { Net exports } & 2 \\ \text { Dividends } & 6 \\ \text { Compensation of employees } & 642 \\ \text { Indirect business taxes } & 101 \\\ \text { Undistributed corporate profits } & 40 \\ \text { Personal taxes } & 116 \\ \text { Corporate income taxes } & 35 \\ \text { Corporate profits } & 81 \\ \text { Government purchases of goods and services } & 233 \\\ \text { Net private domestic investment }\left(I_{\text {net }}\right) & 57 \\ \text { Personal saving } & 60 \\ \text { Calculate, in addition, Personal Income (PI) and Disposable } \\ \text { Personal Income (DPI). } & \end{array}\)

The following data provides a "real-world" illustration of adjusting GNP for changes in the price level (selected years, in billions of dollars). $$ \begin{array}{cccc} \text { Year } & \begin{array}{l} \text { Money, or } \\ \text { unadjusted GNP } \end{array} & \begin{array}{c} \text { Price level } \\ \text { index, percent } \end{array} & \begin{array}{c} \text { Adjusted } \\ \text { GNP } \end{array} \\ 1946 & \$ 209.6 & 44.06 & ? \\ 1951 & 330.2 & 57.27 & ? \\ 1958 & 448.9 & 66.06 & ? \\ 1964 & 635.7 & 72.71 & ? \\ 1968 & 868.5 & 82.57 & ? \\ 1972 & 1,171.5 & 100.00 & ? \\ 1974 & 1,406.9 & 116.20 & ? \\ 1975 & 1,498.9 & 126.37 & ? \end{array} $$ Determine the adjusted GNP for each year.

In a closed economy, there are four firms. The following diagram shows their sales. $$ \begin{array}{lccc} \text { Firm } & \text { Sells } & \text { To } & \text { For } \\ \text { Iron Mine Inc. } & \text { Iron One } & \text { United Steel Co. } & \$ 100 \\ \text { United Steel Co. } & \text { Steel } & \text { Acme Automobiles } & \$ 300 \\ \text { Acme Automobiles } & \text { Cars } & \text { Honest John's Car } & \\\ & & \text { Dealership } & \$ 500 \end{array} $$ Honest John's Car Dealership Cars Consumers $$\$ 1000$$ 1.) Calculate value added by each firm. 2.) Calculate GNP using both the value-added approach and the final goods approach. 3.) A value-added tax of \(10 \%\) is imposed. Calculate each firm's tax payment and tax receipts for the economy. 4.) Compare the results of a \(10 \%\) value-added tax with a \(10 \%\) sales tax imposed on final goods, is there a difference in total tax collected?

Why is it that interest payments on government bonds are not included as income currently earned, particularly, when interest on the bonds of private firms is included in national income as earned income?
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