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For example, if I know in time period 2 I will get paid £x in real terms

Where the real interest rate of borrowing and lending is r% between period 1 and 2

Is this the same as being paid £x/(1+r) in period 1?

Or is this the same as being paid £x in period 1?

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Real income refers to the income of an individual or group after taking into consideration the effects of inflation on purchasing power. For example, if you receive a 2% salary increase over the previous year and inflation for the year is 1%, then your real income only increases by 1%. Conversely, if you receive a 2% raise in salary and inflation is at 3%, then your real income shrinks by 1%.

Net present value is the value today of a stream of income over time - it is influenced primarily by interest rates.

There is some relationship between the terms - because they both discuss the value of money in relationship to to time, but real income discusses the difference of buying power over time due to inflation and NPV focusses on the theoretical equivalence of money today versus a stream of money over a period of time - largely influenced by the risk of receiving that income and the available alternatives of investment during the time period.

Investopedia definition of Real Income

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  • $\begingroup$ Thanks for the answer, but i really don't know what this means for my question about weather it is the same as being paid £x/(1+r) in period 1 or just £x. $\endgroup$ – user15405 Dec 1 '17 at 19:46
  • $\begingroup$ I elaborated a bit - does that help? $\endgroup$ – Bryan Turriff Dec 1 '17 at 19:56
  • $\begingroup$ Right ok, yes I think so. So money paid in real terms is not the same as the present value of that money. In which case i still need to use the discount factor (1+r) in order to find the present value of £x for period 1. $\endgroup$ – user15405 Dec 1 '17 at 20:04
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Suppose you expect to receive £1000 (moninal income) in one year from now. Just to get the setting right, we assume 'now' is year 0 and 'one year from now' is year 1. You expect the inflation rate to be 2% in year 1. Then your real income in year 1 is $$£980.39=\frac{1000}{1+0.02}$$

Now suppose you expect to receive £980.39 in year 1 as above. And you know that nominal interest rate is 5% or in real terms appr. 3%(=5%-2%). Then, the present value of your real income discounted at the real interest rate of 3% is $$951.84=\frac{980.39}{1+0.03}$$

The first demonstrates the calcluation of real income to be received in year 1. The second example shows the calcluation of present value of a future (real) cash flow using real interest rate. So, it depends on what (i.e. inflation rate or interest rate) is used in calcluating the discount factor.

If your £x is a real cash flow in year 1, then you do not need to discount it. Hope this helps.

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