Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What impact does inflation have on real income?

1. Real income increases for all populations

2. Real income remains unchanged

3. Loss of purchasing power for some individuals

4. Improves wealth distribution

The correct answer is: Loss of purchasing power for some individuals

Inflation affects real income by decreasing purchasing power, which is why the statement highlighting the loss of purchasing power for some individuals is correct. When inflation rises, the general price level of goods and services increases, but not all incomes rise at the same rate. Therefore, for individuals whose nominal income does not keep pace with inflation, their real income effectively decreases. This results in a reduction in the amount of goods and services they can buy, leading to a feeling of financial strain despite possibly earning the same nominal salary. In contrast, suggesting that real income increases for all populations does not take into account the variability in income changes relative to inflation rates. Real income remaining unchanged implies that nominal wages and inflation are perfectly balanced, which is seldom the case. Lastly, the notion that inflation improves wealth distribution overlooks the fact that inflation can disproportionately affect low-income earners more severely if their wages do not adjust adequately to inflation, further widening the economic gap rather than improving equity.