Question

Suppose workers and firms expect the overal price level to increase by 5%. Given this, we would expect that

A. real wage will increase by 5%
B. nominal wage will increase by 5%
C. real wage will increase by less than 5%
D. nominal wage will increase by more than 5%

Answer 1

If workers and firms expect a 5% increase in the overall price level, the nominal wage will increase by 5%, as nominal wages typically adjust to reflect expected inflation, maintaining the purchasing power of the wages.

Step-by-step explanation:

If workers and firms expect the overall price level to increase by 5%, we would expect that the nominal wage will increase by 5%.

This is because nominal wages are the dollar amount of wages paid, and if both workers and firms anticipate an overall price level increase, nominal wages are typically adjusted in correspondence with expected inflation to maintain the purchasing power of the wages.

Therefore, the correct option is B: nominal wage will increase by 5%. It's important to differentiate between nominal and real wages because the nominal wage does not take into account the purchasing power or inflation, whereas the real wage is the wage adjusted for inflation and reflects the actual purchasing power.