Final answer:
Cost-of-living adjustments (COLAs) are wage increases indexed to inflation, ensuring that employees' purchasing power remains stable as living costs rise. This was a common feature in wage contracts negotiated by labor unions in the 1970s and 1980s, benefiting both active union members and 'free riders.'
Step-by-step explanation:
Understanding Cost-of-Living Adjustments (COLAs)
A cost-of-living adjustment (COLA) is a pay increase given to employees to counteract inflation. COLAs are essential in ensuring that the purchasing power of an employee's salary does not diminish due to the rising cost of living. This concept was particularly prevalent in the 1970s and 1980s when labor unions frequently secured wage contracts with COLAs to protect workers' earnings against inflationary pressures.
These adjustments are indexed to inflation rates, meaning that if inflation increases, so does the wage. For instance, a contract stipulating a COLA plus 3% ensures that if inflation is at 5%, the total wage increase is 8%. Should inflation reach 9%, the wage increase would be 12%. This method of indexing automatically adjusts wages in line with increases in the cost of living, which makes it a popular system with economists and the general public alike.
The approach helps maintain fair compensation levels that reflect the current economic climate. Such adjustments can aid in protecting the savings of individuals and mitigate the effects of inflation on fixed-income loans. They also address issues related to collective bargaining, where even those not actively participating in union activities ('free riders') may benefit from the negotiated increases.