Chapter 9: Problem 2

Give an example of a money wage and a real wage.

Short Answer

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A money wage example is an individual earning $25 per hour, without considering the effects of inflation. A real wage example is an individual still earning $25 per hour, but due to inflation, they can now afford fewer baskets of goods. Thus, the real wage in terms of purchasing power has decreased.

Step by step solution

Providing a Money Wage Example

A money wage example could be an individual earning $25 per hour. This represents the monetary payment received per hour of work.

Providing a Real Wage Example

For real wages, let's again assume the individual earns $25 per hour and the cost of a basket of goods they usually buy is $50. In a year, they earn $25*2000 = $50,000 (assuming full time work for simplicity i.e. 40 hours a week for 50 weeks). That means they can afford 1000 baskets in a year ($50,000/$50 per basket). If the price of goods doesn't change in the course of the year, this remains constant. Now, if there is inflation and the cost of the basket rises to $55, in reality, they would still earn $50,000 in a year, but now they could only afford about 909 baskets ($50,000/$55 per basket). So, although the money wage is still $25 per hour, the real wage in terms of purchasing power has decreased.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Money Wage

Money wage, often referred to as your 'nominal wage', is the amount of money you get paid before considering the effects of inflation and taxes. It's the actual number you see on your paycheck. For example, if you earn $25 per hour, that's your money wage. It's a straightforward figure that doesn't account for how much you can actually buy with that $25.

Think of it as the 'face value' of your salary or wages. The significance of understanding money wage lies in its simplicity—it tells you precisely how much cash you will receive for work during a given period. However, this simplicity can also be misleading, as it does not provide a complete picture of your economic well-being.

Real Wage

Real wage is what your money wage is genuinely worth when you consider the cost of living or the price of goods and services. It's a measure of your purchasing power. For instance, if you earn a money wage of $25 per hour and a basket of goods you usually buy costs $50, your real wage helps you understand how many of those baskets you can buy.

Suppose in one year you earn $50,000, which at a cost of $50 per basket, allows you to buy 1000 baskets. If inflation occurs and the price for each basket rises to $55, your ability to purchase these baskets decreases to about 909, despite still earning a money wage of $25 per hour. This example shows that even if your paycheck hasn't changed, the real value of your earnings has diminished because your money can't buy as much as it used to.

Purchasing Power

Purchasing power reflects how much you can buy with a unit of currency. In essence, it gauges the real value of your money in terms of goods and services. High purchasing power means your money goes a long way, enabling you to buy more items. On the flip side, low purchasing power means your money buys less.

For example, if inflation leads to a general rise in prices, your purchasing power falls. That's because you’ll need more money to buy the same amount of goods or services than you did before. In the context of wages, your purchasing power directly correlates to your real wage. If your money wage doesn't increase at the same rate as inflation, you'll experience a decrease in purchasing power.

Inflation

Inflation is the rate at which the general level of prices for goods and services rises, eroding your purchasing power. It's typically expressed as a percentage. What it means for you is that over time, you will need more money to buy the same goods and services.

If we assume your money wage is $25 per hour, but over a year there’s a 10% inflation rate, the items you purchase on a regular basis become more expensive. So, your $25 will buy less than it did a year ago. It's crucial to understand inflation because it doesn't just affect your cost of living; it also influences the real value of your wages. In a high inflation scenario, unless your money wage increases at the same rate or higher, your real wage effectively decreases.