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Intermediate · 3 min

Separating prices from purchasing power

A nominal value is measured in current money. A real value adjusts for changes in prices. If income and all relevant prices rise by the same proportion, purchasing power is unchanged. A broad price index is an approximation because a person’s spending basket may differ from the measured basket.

Practice

Income and the cost of the same shopping basket both rise by 5%. What happens to purchasing power for that basket?