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Chapter 20: Problem 1

Why do nominal incomes generally increase with inflation? If nominal incomes increase with inflation, does inflation reduce the purchasing power of an average consumer? Briefly explain.

Short Answer

Expert verified
Nominal incomes generally increase with inflation because employers often raise wages to keep up with or surpass the inflation rate in order to maintain their employees' standard of living. However, even with an increase in nominal income, inflation can decrease the purchasing power of an average consumer if the rate of price increase surpasses the rate of nominal income increase.

Step by step solution

01

Definition of terms

Define the key terms. Nominal income refers to the amount of money earned by an individual or household over a certain period, without taking into account inflation. Inflation, on the other hand, refers to the rate at which the general level of prices for goods and services is rising.
02

Relationship between Inflation and Nominal Income

Explain how nominal incomes generally increase with inflation. Employers often increase wages to match or exceed the inflation rate to maintain employees' standards of living. Therefore, as prices rise due to inflation, nominal incomes generally tend to increase as well.
03

Effect of Inflation on Purchasing Power despite increase in Nominal Income

Even though nominal incomes may increase with inflation, it does not necessarily mean that the purchasing power of an individual increases. This is because inflation erodes the purchasing power of money; while one's nominal income may rise, the cost of goods and services may rise at a faster rate, leaving an individual with less purchasing power.

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Most popular questions from this chapter

(Related to the Don't Let This Happen to You on page 681 ) Briefly explain whether you agree with the following statement: "I don't believe the government price statistics. The CPI for 2016 was \(240,\) but I know that the inflation rate couldn't have been as high as 140 percent in \(2016 . "\)

In May 2017, an article in the New York Times had the headline: "We're Getting Awfully Close to Full Employment." The article contained the following observation: "The socalled \(U-6\) rate \(\ldots\) fell to 8.6 percent in April from 8.9 percent [in March]." a. What is the U-6 unemployment rate? Why do economists and policymakers track changes in this measure of the unemployment rate? b. What is full employment? If the U.S. economy was close to full employment in May 2017 , why was the \(\mathrm{U}-6\) measure of the unemployment rate still as high as \(8.6 ?\)

An article in the Wall Street Journal noted that over a fourmonth period in late 2014 , employment in the state of Georgia "rose \(1 \%\) even as the state's jobless rate climbed 1.2 percentage points." Briefly explain how the state's unemployment rate could have increased at the same time that employment in the state was increasing.

What is the difference between a nominal variable and a real variable?

In April \(2016,\) the nominal interest rate on a one-year Treasury bill was 0.54 percent. From April 2016 to April \(2017,\) the consumer price index rose from 238.9 to \(244.2 .\) If you bought the one-year Treasury bill in April 2016, calculate the real interest rate you earned over the following 12 -month period. Given the results of your calculation, why were investors willing to buy Treasury bills in April \(2016 ?\)
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