Problem 13 What is the relationship between... [FREE SOLUTION]

Chapter 6: Problem 13

What is the relationship between your nominal income and the inflation rate if you are more than keeping up with inflation?

Short Answer

Expert verified

If you are more than keeping up with inflation, your nominal income increases faster than the inflation rate. This allows you to increase your purchasing power, as you can afford the same amount or even more goods and services than before, despite increased prices.

Step by step solution

Understand the key terms

Nominal income is the amount of money a person earns in a given period. Inflation is defined as the increase in the general price level of goods and services in an economy over a period of time. When inflation increases, each unit of currency buys fewer goods and services. 'Keeping up with inflation' means your income increases at the same rate as the inflation rate, thus allowing your purchasing power to remain constant.

Explain the general relationship

For most people, if their nominal income stays constant and inflation rises, they lose purchasing power because their income doesn't stretch as far to cover for the increased prices. This is because the value of each unit of income is reduced, as it can purchase less goods and services than before.

Explain the specific case

If a person is more than keeping up with inflation, it means that their nominal income is increasing faster than the rate of inflation. Even as prices increase, the individual's income is increasing at a faster rate, hence they are able to afford the same amount or even more goods and services despite the increased prices. In essence, their real income (purchasing power) is increasing.