How much more can you buy after a pay raise?

Suppose your hourly wage rises from $25 to $26. The extra dollar is a 4% raise. If the price index you are using rose by 5% over the same period, the new hourly wage buys a little less of the representative basket. You can estimate the difference by converting the new wage to the prices that applied before the raise.

Put pay and prices on the same basis

Economists call the dollar amount paid nominal pay. Real pay is the amount adjusted for price changes. The U.S. Bureau of Labor Statistics explains the adjustment using a consumer price index. Divide the new wage by the new index divided by the old index.

Imagine the index goes from 100 to 105. The ratio is 1.05. Divide $26 by 1.05 to get about $24.76 in starting-period dollars. Compared with the original $25, purchasing power per hour fell about 0.95%. The figures are fictional. They use the same pair of dates for the wage and the index.

Choose the pay figure that answers the question

An hourly raise and a change in the amount you take home over a week are separate calculations. If paid hours fall, weekly earnings may fall even with a higher hourly rate. In the same example, 40 hours at $25 yielded $1,000 before deductions. At $26 for 38 hours, weekly pay is $988 before deductions. Adjust that new amount separately if the question is what the week’s pay can buy.

Decide whether you want to compare gross wages or your actual take-home amounts. Taxes and deductions can change between periods. A household that spends much more of its income on a fast-rising expense can experience a larger change in buying power than a broad index suggests.

Make the comparison repeatable

• Use the same kind of wage or income for both periods.
• Find the same consumer price index for the two matching dates.
• Divide the later pay by the ratio of the two index values.
• Compare the result with the original pay and state which prices you used.

Subtracting 5% inflation from a 4% raise gives a quick estimate of about a 1% decline. The ratio gives the exact change for the example before rounding. Keep the source index and dates alongside the result so someone else can reproduce it.