A labor contract provides for a first-year wage of $10 per hour, and specifies that the real wage will rise by 3 percent in the second year of the contract and by another 3 percent in the third year. The CPI is 1.00 in the first year, 1.07 in the second year, and 1.15 in the third year. What dollar wage must be paid in the third year?
A)$10.61
B)$11.15
C)$12.20
D)$12.31

Question

Quizplus · Accepted Answer

Note that since the first year is also the base year, the real wage and nominal wage are both $10 per hour in that year. Since the real wage is supposed to increase by 3 percent in the second year, the real wage in year two must be $10.30 ($10 × 1.03)per hour. Similarly, the real wage should also increase by 3 percent in the third year, so the real wage in year three must be $10.609 ($10.3 × 1.03)per hour. In order to find the nominal wage in year three, we must index this real wage to adjust for inflation. The nominal wage in year three must be $12.20 ($10.609 × 1.15).

A Labor Contract Provides for a First-Year Wage of $10