Pre-reading

Session 4
Macro-Economics

Real vs Nominal Money

 Nominal values are the current monetary values.

 Real values are adjusted for inflation and show prices/wages at constant prices.
 Real values give a better guide to what you can actually buy and the opportunity costs
you face.

Example of real vs nominal

 If you receive an 8% increase in your wages from £100 to £108, this is the nominal
increase.
 However, if inflation is 2%, then the real increase in wages is (8-2%) 6%.
 The real wage is a better guide to how your living standards changes. It shows what you
are actually able to buy with the extra increase in wages.
 If wages increased 80%, but inflation was also 80%, the real increase in wages would be
0% – in effect, despite the monetary increase in wages of 80%, the amount of goods and
services you could buy would be the same.
Converting nominal prices to real prices

How much is £1,000 from 1940 worth in today’s (1990) money?

 1940: Consumer price index CPI =  32

 1990: Consumer price index CPI = 184
 Past value in real terms of current Pounds = CPI in start year ÷ CPI index at end year
 Therefore $1,000 × 184÷32 = £5,750

How much is a £200,000 house worth in 1940’s money?

 1940 Consumer price index CPI = 32

 1990 CPI = 184
 Real value of good in previous years money = CPI in start year x CPI at end year
 £200,000 x 32 ÷ 184 = £34,782