Real income can be defined at two levels. As a statistic, it is money income corrected for changes in prices. If a person’s income rose from $20.000 in 1980 to $25,000 in 1981, we say that the growth in his money income was 25 per cent, (25–20)/20 expressed as a percentage. However, if the price level rose from 100 in 1980 to 110 in 1981, we say that the growth in his real income was only 13.64 per cent [(25/110)–(20/100)]/(20/100). But statistics are not just manipulations of data, and real income is not completely defined until we identify the characteristic, property or aspect of the economy the statistic is intended to reflect. Real income must be defined as a concept as well as a statistic, to indicate what the statistic is for and to serve as a guide in choosing and manipulating the original data from which the statistic is compiled. In particular, the rules for constructing a price index to deflate money income into real income can only be established with reference to the information the statistic is designed to convey.
- For a survey of the concept of real income with an extensive bibliography see A.K. Sen, ‘The welfare basis of real income comparisons. 1979. Journal of Economic Literature: 1–45.Google Scholar
- On the measurement of prices in the presence of quality change, see George Stigler and James Kindahl, The behavior of industrial prices. New York: Columbia University Press, 1970, and Zvi Griliches (ed.), Price indexes and quality change: Studies in new methods of measurement. Cambridge, MA: Harvard University Press, 1971.Google Scholar
- The distinction between the welfare and productive capacity interpretations of real income is due to John Hicks. 1940. The valuation of social income. Economica 7: 105–124.Google Scholar