What is the real income increase of an employee who received a 5% raise in a year with 3% inflation?

To determine the real income increase of the employee, it's important to understand the relationship between nominal income, inflation, and real income. Nominal income is the amount of money earned without adjusting for inflation, while real income reflects the purchasing power of that income in terms of actual goods and services available, adjusted for inflation.

In this scenario, the employee received a 5% raise, meaning their nominal income has increased by that amount. However, there is also an inflation rate of 3%. Inflation diminishes the purchasing power of money, so to calculate the real income increase, we need to adjust the nominal raise by the rate of inflation.

The formula to find the real income increase is:

Real Income Increase = Nominal Income Increase - Inflation Rate

Applying the values from the scenario:

Real Income Increase = 5% (raise) - 3% (inflation) = 2%

Thus, the real income increase of the employee is 2%. This indicates that while the employee's nominal salary has gone up, their actual purchasing power has only increased by 2% due to the effect of inflation, which effectively erodes some of the gains from the raise.