Suppose workers negotiate for a 5 percent nominal wage increase and expect a 8 percent inflation rate. If the actual inflation rate is 4 percent, then workers
A) and firms are both better off.
B) are better off and firms are worse off.
C) are worse off and firms are better off.
D) and firms are both worse off.

Question

Quizplus · Accepted Answer

If workers negotiate for a 5% nominal wage increase and expect an 8% inflation rate, they are effectively negotiating for a 3% real wage increase (5% - 8% = -3%). However, if the actual inflation rate is 4%, then the real wage increase is actually 1% (5% - 4% = 1%). Therefore, workers are better off (they receive a higher real wage increase than they expected), but firms are worse off (they have to pay higher wages than they expected).

Suppose Workers Negotiate for a 5 Percent Nominal Wage Increase