Question

Behavioral economists have discovered that people view a 2% decrease in their income without inflation as unfair but a 3% increase in their income in the presence of 5% inflation as fair. a. What are the nominal and real rates of change in their incomes? Nominal change in income = % Real change in income = % b. What tendency is leading people to feel like the pay decrease is unfair? The cost-benefit principle The opportunity cost principle Shoe-leather costs Money illusion

Answer 1

Answer: See Explanation

Step-by-step explanation:

Based on the information given in the question, we should note that the real interest rate is calculated as:

= Nominal interest rate - inflation rate

In this case, the real interest rate will then be:

= 3% - 5%

= -2%

Real change in income = -2%

Nominal change in income = 3%

The tendency that is leading people to feel like the pay decrease is unfair is the money illusion. This simply means that rather than thinking of money based on its purchasing power, that is in real terms, one thinks of it in nominal term which is in its far value form.