Question

In: Economics

Megan currently earns a (real, nominal) wage of $12.00 per hour; in other words, the amount...

Megan currently earns a (real, nominal) 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 milk is $3.00 per gallon; in this case, Megan's (nominal, real) wage, in terms of the amount of milk she can buy with her paycheck, is [#] gallons of milk 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 (real, nominal) wage with those expectations in mind. If the price level turns out to be higher than expected, a worker's (real, nominal) wage is (lower, higher) than both the worker and employer expected when they agreed to the wage.

Megan 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 6%, not 3%. For example, suppose the price of milk rose from $3.00 per gallon to $3.18 per gallon. This means that between 2012 and 2013, Megan's nominal wage (increased, decreased) by [ %], and her real wage (increased, decreased) by approximately (1%, 2%, 3%, 4%, 5%, 6%).

Solutions

Expert Solution

Megan currently earns nominal wage of $12 per hour.

Price of milk = $3

Real wage in terms of amount of milk = (Nominal wage / Price of milk) = ($12 / $3) = 4

Megan real wage in terms of the amount of milk she can buy with her paycheck is 4 gallons of milk per hour.

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When workers and firms negotiate compensation packages, they have expectations about the price level (and changes in the price level) and agree on a nominal wage with those expectations in mind. If the price level turns out to be higher than expected, a worker's real wage is lower than both the worker and employer expected when they agreed to the wage.

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Megan nominal wage increase by 3% from $12 to $12.36 be keeping expected inflation rate of 3%.

But the actual infaltion rate is 6%. It means the price of milk rises by 6% from $3 to $3.18.

But the nominal wage increase by 3%.

Real Wage = Nominal wage / Price of milk.

=> % change in real wage = % change in nominal wage - % change in price of milk

=> % change in real wage = 3% - 6%

=> % change in real wage = -3%

This means that between 2012 and 2013, Megan's nominal wage increased by 3%, and her real wage decreased by approximately 3%

Rahul Sunny answered 2 years ago
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