What does real income measure?

Real income is a crucial economic concept that measures the purchasing power of an individual's money income over time, adjusted for changes in the price level. This means it reflects how much goods and services can actually be bought with the income received, considering inflation or deflation. When prices rise, even if nominal income remains the same, the real income decreases because it can buy fewer goods and services. Conversely, if prices fall, real income increases.

This understanding is vital because it goes beyond just looking at the amount of money someone earns; it considers how that money can be spent and its effectiveness in terms of purchasing power, which is influenced by inflation and cost of living changes.