Can someone break down the difference between real and nominal value in simplistic terms?

Question

I have read the wiki entry on this here:

http://en.wikipedia.org/wiki/Real_versus_nominal_value

I understood most of it, but the calculation is not laid out in the best manner and doesn't explain things too well.

I also read this link that explains the difference:

http://economics.about.com/cs/macrohelp/a/nominal_vs_real.htm

but the 3rd example of wages over a 2 year period is not well explained - how does he arrive at year 2 real wages of $49,107, and, can someone explain why the forumlae is laid out as it is please?

If someone could do it in laymans terms (as much as possible) and also give me a few examples - say for real VS nominal wages and a commodity, say house prices, over a 5 year period to illustrate exactly what is going on, i would really appreciate it.

Many thanks!

Answer 1

It is really quite simple.
Let's take wages as an example.
Your nominal wage is the dollar amount that you see on your paycheck. Let's say, for argument's sake, that it was US$1,000.
Now, you want to see if you are making more money today than you were, say... 10 years ago. So, you go to your paycheck 10 years ago and see that it was US$700. So, you are making more money today than you were 10 years ago... RIGHT?

Not quite the answer.

10 years ago, you could buy more with 1US$ than you can now, so maybe your US$700 got you more stuff ten years ago than your US$1,000 do now. How can you tell? You compare real wages.
To do that you need to deflate your current wage to make it comparable to your wage 10 years ago. Let's say that, in the past ten years, inflation was 80% (for the total period, not per year). This means that prices have gone up 80% in 10 years or, for your calculation, that 80% of the value of each of your dollars has dissappeared. So you take your US$1,000 and you divide them by (1+ inflation for the period) and you get US$555.56
So, in real terms, your wage has decreased. Why? Because with your US$700 you could buy more 10 years ago than you can today with your US$1,000 . How do you know this? Because when you compare your wage in real terms, you find out that today you make US$144.44 less than you did 10 years ago (in dollars from 10 years ago).
Notice that, to compare, you converted your current nominal wage into a real wage in terms of US$ from 10 years ago. You could have done it the other way arround and made the comparison in today dollars. To do so, you would have to multiply your wage 10 years ago by (1+ inflation for the period). Your answer would be US$1,260 which is higher than the US$1,000 you make today. This says that, to buy today what you could buy with your US$700 ten years ago, you would need US$1,260 today.

Answer 2

Real Value Vs Nominal Value

Answer 3

I don't want to go too long here, but think in terms of "nominal" being a number and "real" being reality. In the case of wages, say you get a nominal merit increase of 3.5% annually, however, inflation or prices increase 3% over that time period, then your real wages grew by .5%. Yes, you received a 3.5% raise, but the cost of living increased 3%, so your real wages or standard of living in reality only inreased by half a percent.

Answer 4

warm - touching on to fantastically spiced or particularly heated to the point of it turning out to be insufferable to the contact. superb - damaged down into peices sufficiently small to virtually be seen debris. horny - To be seen so pleasing that you would imagine having "sex" with that individual. it type of feels by theyr definishuns that none of those words have any relashun with eachuther :)

Answer 5

nominal value is the value that you or others put on an item the real value is what others will pay or it's retail