Distinguish between money wages and real wages.

Money wages (also known as nominal wages) refer to the amount of money paid to a worker for their work or services. This is the actual dollar amount the worker receives before considering the effects of inflation or the purchasing power of that money.

Real wages, on the other hand, refer to the amount of goods and services the worker can actually buy with their money wages. It takes into account the effects of inflation and the cost of living. To calculate real wages, we need to adjust money wages for changes in the price level or purchasing power.

The key difference between money wages and real wages lies in the consideration of inflation and purchasing power. While money wages tell us the exact amount of money earned, it does not give us an accurate picture of how well-off a worker is in terms of what they can actually afford to buy with their earnings. Real wages, on the other hand, provide a clearer view of a worker's purchasing power by taking into account changes in the overall price level in the economy. A higher real wage means that the worker can buy more goods and services with their earnings.

Let's consider an example for better understanding. Suppose a worker earns $50,000 a year (money wage) and the consumer price index (CPI), which measures the average price level of goods and services, is at 100. Now let's say, after a year, the worker's annual salary increases to $51,000 (money wage), and the CPI increases to 102 (indicating a 2% inflation rate). To calculate the real wage, we need to adjust the money wage for inflation. Real Wage (Initial) = \(\frac{Money\,Wage\,(Initial)}{CPI\,(Initial)}\) * 100 Real Wage (Initial) = \(\frac{50,000}{100}\) * 100 = $50,000 Real Wage (New) = \(\frac{Money\,Wage\,(New)}{CPI\,(New)}\) * 100 Real Wage (New) = \(\frac{51,000}{102}\) * 100 ≈ $50,000 In this example, even though the worker's money wage increased, their real wage remained approximately the same, meaning the worker's purchasing power has not increased significantly due to inflation.