Question

Workers and management agree on a contract that gives a 5% wage increase for each of the next three years. Everyone expected 3% inflation but inflation turned out to be 5% per year. Then at the end of three years...

a. real wages will be higher than was expected.

b. real wages will have fallen

c. nominal and real wages will have changed by the same percentage.

d. real wages will be lower than was expected.

Answer 1

The correct option is (d)

Step-by-step explanation:

Real wages are nominal wages less inflation. Nominal wage is not adjusted for inflation. Everyone had expected an inflation of 3% per year while increase in wages per year is 5%. This implied that they will expect real wage of 2% (5% - 3%) per year.

However, it turned out that inflation was 5% per year. This means that real wages were actually 0% (5% - 5%). There was no increase in real wages at all. So, they received lower real wage (actually nil) as against expected real wage of 3% per year.