Question

Caroline currently earns a real wage of $12.00 per hour; in other words, the amount of her paycheck each week is $12.00 per hour times the number of hours she works. Suppose the price of orange juice is $2.00 per gallon; in this case, Caroline's wage, in terms of the amount of orange juice she can buy with her paycheck, is gallons of orange juice per hour. When workers and firms negotiate compensation packages, they have expectations about the price level (and changes in the price level) and agree on a wage with those expectations in mind. If the price level turns out to be higher than expected, a worker's wage is than both the worker and employer expected when they agreed to the wage. Caroline and her employer both expected inflation to be 3% between 2012 and 2013, so they agreed, in a two-year contract, that she would earn $12.00 per hour in 2012 and $12.36 per hour in 2013. However, suppose inflation between 2012 and 2013 actually turned out to be 5%, not 3%. For example, suppose the price of orange juice rose from $2.00 per gallon to $2.10 per gallon. This means that between 2012 and 2013, Caroline's nominal wage by % , and her real wage by approximately .

Answer 1

If the price level turns out to be lower, the real wage is higher than expected.

Therefore the nominal wage increased by 3% and real wage increased by 1%.

Step-by-step explanation:

When wage is stated in terms of currency, it is nominal wage. When wage stated in terms of amount of some good that can be brought by it, it is real wage. Real wage is calculated by dividing nominal wage by price.

Person C earns a nominal wage of $12.00 per hour. The price of milk is $3 per gallon. This means C's real wage is 4 (=12/3) gallons of milk per hour.

When workers and firms negotiate, they agree on a nominal wage with inflation expectations in mind. If the price level turns out to be lower, the real wage is higher than expected.

In 2020, C's nominal wage is $12 and her real wage is 4 gallons of milk. In 2011, her nominal wage is $12.36 and her real wage is 4.04 (=12.36 / 3.06)

Increase in nominal wage between 2010 and 2011 = 12.36 - 12.00 /12.00

= 0.36 / 12.00 = 0.03 or 3%

Increase in real wage between 2010 and 2011 = 4.04 - 4.00 / 4.00

=0.04 / 4.00

=0.01 or 1%

Therefore the nominal wage increased by 3% and real wage increased by 1%