University:
Baltimore City Community College
Course:
ECO 201 | The American Economy I: Macroeconomic Theory
Academic year:

2024
Views:

440

Pages:

2
Author:

Danny A.

Nominal Wages versus Real Wages Wages are a measure of both hourly payments for labor services by business firms and hourly compensation to workers. Nominal wages are hourly payments to workers in current dollars. Real wages are nominal wages deflated to adjust for changes in the purchasing power of the dollar since a certain base period. Real wages give hourly compensation in terms of base period dollars. For example, suppose nominal hourly wages in 1995, including the hourly dollar value of fringe benefits, are $20. If the consumer price index is 200 in 1995 (and 1982-1984 is the base), then the purchasing power of a 1995 dollar is only one half of a 1982-1984 average dollar. It follows that the real wage expressed in terms of base period dollars is only $10. To find out whether real wages increased between 1982 and 1995, we then would compare actual wages in 1982 with real wages in 1995. The graph in Box 5 shows the percentage change in the consumer price index and the percentage change in hourly employee compensation (the hourly nominal wage and the nominal value of hourly fringe benefits) from 1960 to 1990. In most years, the percentage change in hourly employee compensation exceeds the percentage change in prices. Therefore, in most years, the growth rate of nominal wages (including the value of fringe benefits) exceeds inflation, because employers compensate workers not only for changes in the price level but also for changes in productivity. The graph shows that, on average, competition for labor services has resulted in a nominal wage growth exceeding the inflation rate. On average, real wages in the United States have increased each year. The increase in the real wage reflects increases in labor productivity. You should also observe that the annual percentage change in labor compensation and the inflation rate move together. However, there's often a lag between the increase in consumer prices and the increase in nominal hourly labor compensation. During periods of rapid inflation the rate of increase in consumer prices often exceeds the rate of increase in nominal hourly labor compensation. For example, during the periods of rapid inflation from 1973 to 1975 and from 1979 to 1981, inflation did outstrip annual increases in hourly labor compensation. Real wages therefore fell over that period. Similarly, in 1984 inflation outstripped the growth of nominal wages, resulting in a decline in real wages. During periods of rapid inflation, when real wages decline, workers' hourly compensation falls. Who gains? The answer is employers, who end up paying less in hourly labor costs. As a result, during periods in which inflation exceeds the percentage increase in nominal wages (hourly labor compensation), there is a redistribution of income from workers to their employers. This is one of the capricious effects of inflation on the distribution of income. Workers do consider inflation when engaging in contract negotiations that set wages. By and large the growth in nominal wages and inflation move together because workers demand increases to offset the effects of inflation. Nominal increases in hourly compensation lag behind inflation only in periods when inflation heats up rapidly.