Real money and nominal money are two concepts used in economics to describe the value of money. Understanding the difference between them is crucial for grasping how inflation and purchasing power affect the economy.
Nominal Money
Nominal money refers to the face value of money. It is the amount of money that is written on the currency, such as $10 or €50. Nominal money does not take into account the purchasing power or the effects of inflation. For example, if you have $100 today, it is still $100 in nominal terms a year from now, regardless of whether its purchasing power has changed due to inflation.
Real Money
Real money, on the other hand, takes into account the purchasing power of money. It adjusts the nominal value of money to reflect the effects of inflation or deflation. Real money is a measure of how much goods and services money can actually buy. For example, if you have $100 today and inflation is 5% over the next year, the real value of that $100 will be $95 in terms of today’s purchasing power.
Key Differences
- Value Consideration: Nominal money is the face value of money, while real money considers the purchasing power.
- Inflation Impact: Nominal money does not account for inflation, whereas real money adjusts for inflation or deflation.
- Economic Analysis: Real money is often used in economic analysis to understand the true value of money over time, while nominal money is used for day-to-day transactions.
In summary, nominal money is the amount of money in terms of its face value, while real money reflects the actual purchasing power of that money, taking into account inflation or deflation.