Question

Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously. Who loses from inflation? Who gains?

Short answer

• If an increase in the price level accompanies an increase in the nominal income, the real income can decrease simultaneously.

• Fixed-income receivers, savers, and creditors lose from inflation.

• Flexible-income receivers and borrowers gain from inflation.

Step-by-step solution

Simultaneous increase in nominal income and decrease in real income 

Nominal income is the income received in figures through different sources like wages, rent, interest, or profit. On the other hand, real income is defined by your purchasing power, and it reflects the impact of inflation. The following formula calculates the real income:

$RealIncome=\frac{NominalIncome}{PriceIndex}$

If the price index remains constant, the real income will increase with an increase in nominal income. However, if the price index rises more than the nominal income, the real income will decrease despite increasing nominal income.

For example, if the nominal income rises from 4% to 6% and the price index increases from 4% to 8%, the real income will decrease from 1% to 0.75%.

Gains and losses from inflation

Inflation brings losses to fixed income receivers, lenders, and savers. As the price level rises, the purchasing power of the fixed nominal income and savings reduce. Similarly,when the price level goes up, the real value of lenders' money lent in the past declines, and they receive back a lower real value of interest payment on the loaned amount.

On the contrary, inflation is helpful for borrowers and flexible-income receivers. As inflation rises, the nominal income of flexible income receivers also increases. Therefore, their purchasing power either remains the same or improves.