Real income is income of individuals or nations after adjusting for inflation. It is calculated by subtracting inflation from the nominal income. Real variables, such as real income, real GDP, and real interest rate are variables that are measured in physical units, while nominal variables such as nominal income, nominal GDP, and nominal interest rate are measured in monetary units. Therefore, real income is a more useful indicator of well-being since it is based on the amount of goods and services that can be purchased with the income.
According to the classical dichotomy theory, real variables and nominal variables are separate in the long run, so they are not influenced by each other. In other words, if the nominal starting income was 100 and there was a 10% inflation (general rise in prices, for example, what cost 10 now costs 11) rate. Now with 100, one can buy less and if income is not adjusted by inflation (did not rise by 10%), real income has dropped 10%.
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