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Q. 22

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Principles of Economics
Found in: Page 470

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Short Answer

Should people typically pay more attention to their

real income or their nominal income? If you choose the latter, why would that make sense in today’s world? Would your answer be the same for the 1970s?

People should pay more attention to their real income. The inflation level in today's world is low so it would be better to choose national income. In 1970s, with high inflation, nominal values fail to reflect the real power.

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Step by Step Solution

Step 1. National income

The value that is expressed in monetary terms is known as the nominal value. It permits currency values to vary.

Step 2. Real income

Real value is calculated by subtracting the effects of price fluctuations from the nominal value.

Step 3. Importance

People should focus more on their real income. This is due to the fact that real income purchases money's actual purchasing power. Money's purchasing power is its value expressed in terms of the goods and services that one unit of money can purchase.

Step 4. Choice in today's world

The degree of inflation in today's world is low, and nominal values are not a problem when inflation is low. As a result, in today's world, it would make sense if individuals paid more attention to nominal income.

Step 5. Choice in 1970s

When the rate of inflation is high, as it was in 1970, it is inadvisable to focus solely on nominal income. This is because when inflation is high, individuals believe their nominal income has increased as well, and this perception makes them worse off because high inflation diminishes people's purchasing power in real terms.

With high inflation, nominal values fail to reflect a dollar's real value.

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