Assume contracts between workers and employers that call for an increase in the wage rate of 5 percent are based on an expected inﬂation rate of 3 percent. Should inﬂation actually be 6 percent,
Then
A) nominal wages fall by 5 percent.
B) real wages fall by 6 percent.
C) nominal wages fall by 1 percent.
D) real wages fall by 1 percent.

Question

Quizplus · Accepted Answer

If the expected inflation rate is 3% and the actual inflation rate turns out to be 6%, then there is an unexpected increase in inflation of 3%. This means that the real wage increase is not as large as expected, because prices are rising more quickly than anticipated.

To calculate the real wage increase, we can subtract the inflation rate from the nominal wage increase:

Real wage increase = Nominal wage increase - Inflation rate

Real wage increase = 5% - 6%

Real wage increase = -1%

This means that real wages actually fall by 1%. While nominal wages still increase by 5%, the rise in prices wipes out some of the purchasing power gained by the higher wage rate.

Assume Contracts Between Workers and Employers That Call for an Increase