Question

If your nominal income rises by 5.3 percent and the price level rises by 3.8 percent in some year, by what percentage will your real income (approximately) increase? If your nominal income rises by 2.8 percent and your real income rises by 1.1 percent in some years, what is the (approximate) inflation rate?

Short answer

The real income will rise by 1.5%.

The inflation rate is 1.7%.

Step-by-step solution

Explanation for part (a)

Real income reveals the actual purchasing power of the currency, irrespective of inflation or deflation. Real income is calculated when the price effect is excluded from the nominal income.

Real Income = Nominal Income – Inflation

Thus, the increase in the real income is 1.5% (= 5.3 - 3.8).

Explanation for part (b)

Nominal income increases by 2.8%, and real income increases by 1.1%

$$\begin{gathered} \mathrm{Real}\mathrm{Income}=\mathrm{Nominal}\mathrm{Income}-\mathrm{Inflation} \\ 1.1=2.8-\mathrm{Inflation} \\ \mathrm{Inflation}=2.8-1.1 \\ =1.7\% \end{gathered}$$

Hence, the inflation rate is 1.7%.