ECON 100 Sunshine Sandwich Shoppe

St. Charles Community College
ECON 100   Survey Economics
Real Income and the Sunshine Sandwich Shoppe

In order to demonstrate the difference between nominal and real values, let’s assume an imaginary sandwich shop which we will name the Sunshine Sandwich Shoppe. Let’s also assume that we want to study two periods in the existence of this sandwich shop, the year 2000 and the year 2003.  Let’s further assume that there are only four items on the menu at this sandwich shop.  The items on the menu have not changed, but the prices have.

We should first define our terms and clarify our approach in this exercise.  Nominal prices are the prices paid for goods at the time of purchase.  They are the out-of-pocket costs of goods.  Real prices are nominal prices that have been corrected for inflation.  For example, if a firm sells 100 items at \$1.00 each in the year 2002, and then sells another 100 of the same items at the price of \$1.25 the in the year 2003, the firm’s total revenue has increased in nominal terms, but in terms of real production (corrected for price inflation) there has been no increase in production.  As related to output, there is no growth.

 Sandwich Menu Items Price, \$(2000)(a) Price, \$(2003)(b) Quantity/Day(2000)( c ) Quantity/Day(2003)(d) Nominal  Income \$(2000)(a x c) Nominal Income \$(2003)(b x d) Hamburger With French Fries 3.75 5.25 25 30 93.75 157.50 CheeseburgerWith French Fries 4.25 5.95 30 35 127.50 208.25 Grilled Chicken With Cole Slaw 4.25 6.25 20 25 85.00 218.75 Fish SandwichWith Potato Salad 4.05 6.50 30 35 121.50 162.50 Total Nominal Income 427.75 747.00

Now let’s see how the total revenue from the two periods compare by finding the total revenue increase in the periods in nominal terms:

(747.00 – 427.75)
Nominal increase in total revenue = ---------------------- = 0.746 or 75 %  increase
(427.75)

Now let’s look at the same problem in real terms.  Remember,  when we deal in real terms we correct for price level increases which is another way of saying that we correct for inflation.

In order to accomplish this we will multiply the output from year 2003 (column d in the above chart) times the prices in the year 2000 (column a in the above chart.  This way we have taken the inflation (the price increases) out of the problem.

 Sandwich Menu Items Price, \$(2000)(a) Price, \$(2003)(b) Quantity/Day (2000) (c) Quantity/Day(2003)(d) Nominal Income, \$2000 (a x c) Real Income, \$2003(a x d) Hamburger with French Fries 3.75 30 112.50 CheeseburgersWith French Fries 4.25 35 148.75 Grilled Chicken withCole Slaw 4.25 35 148.75 Fish SandwichWith PotatoSalad 4.05 25 101.25 Total Real Income 511.25

(511.25 – 427.75)
Real increase in total revenue = ---------------------- = 0.195 or 20 %  increase
(427.75)

Based on these calculations, please note that the increase in revenue by the Sunshine Sandwich Shop is primarily due to the owner’s ability to raise prices and not to the shop’s increase in sandwich production.

Before we leave this example, let’s remember that in measuring gross domestic product we are measuring national output. We use real values to compare data from different periods in order to take price increases out of the picture.