Question

Assuming that the inflation rate from 2013 through 2015 is 6% per year:

a) What would be the real value of a $25,000 income in each of the three years? (Show all work)

b) What does the real income for 2014 mean?

Answer 1

Ans. Suppose we take 2013 as base year, so, prices in year 1 are $1

Then, real value of Income in 2013 = 25000/1 = $25000

As inflation rate is 6%, then price level in 2014 increases by 6%, so, new price level = $1.06

So, real value of income in 2014 = 25000/1.06 = $23584.9057

Now, in 2015, inflation is again 6%, so, price level again increases by 6%, new price level = 1.06*1.06 = $1.1236

Thus, real income in 2015 = 25000/1.1236 = $22249.911

b) Real income for 2014 means that now the person will be able to buy $23584.9057 worth of goods at the 2013 price level.

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