Question

Grant Smith was a doctor. In 1944, he made $12,000. His daughter, Lisa Smith, is also a doctor. Last year, she made $275,000. The price index in 1944 was 17.6, and the price index last year was 200. Using this information, what can be concluded about the changes in their real incomes over time?

A) Grant Smith experienced a decrease in real income, while Lisa Smith experienced an increase.
B) Both Grant Smith and Lisa Smith experienced an increase in real income.
C) Both Grant Smith and Lisa Smith experienced a decrease in real income.
D) Grant Smith experienced an increase in real income, while Lisa Smith experienced a decrease.

Answer 1

After adjusting their nominal incomes for inflation using the price indexes, Grant Smith's real income in 1944 was higher than Lisa Smith's last year. Grant Smith experienced an increase in real income, while Lisa Smith experienced a decrease. The correct answer is D.

Step-by-step explanation:

To determine the changes in real incomes over time for Grant and Lisa Smith, we need to adjust their nominal incomes for inflation using the provided price indexes. The formula to calculate real income is:

Real Income = Nominal Income / (Price Index / 100)

First, for Grant Smith in 1944:

Real Income = $12,000 / (17.6 / 100) = $68,181.82 (approximately)

Next, for Lisa Smith last year:

Real Income = $275,000 / (200 / 100) = $137,500

Comparing their real incomes, Grant Smith made a higher real income than Lisa Smith, once adjusted for inflation. Therefore, it can be concluded that despite Lisa Smith having a higher nominal salary, when adjusted for changes in the price level over time, Grant Smith actually had a greater purchasing power.

Hence, the correct conclusion is:

D) Grant Smith experienced an increase in real income, while Lisa Smith experienced a decrease.