Question

Over the past three years Rachel's money wage increased by 10 percent, and prices increased by 13 percent. Has Rachel's real wage increased, decreased, or remained stable? Explain your answer.

Short answer

Rachel's real wage has decreased by 3%.

Step-by-step solution

Determine the money wage increase percentage

Rachel's money wage increased by 10%. The result can be represented by the equation \( M_{final} = M_{initial} + (0.10 * M_{initial}) \) where \( M_{initial} \) is Rachel's original wage and \( M_{final} \) is her final wage.

Compare it to the inflation rate

The overall inflation, or price increase, is 13% over the same period.

Determine the real wage

To find out how the inflation impacted Rachel's purchasing power, we can subtract the inflation rate from the wage increase. Therefore, \( Real Wage Change = Wage Increase - Inflation = 10% - 13% = -3% \)

Key concepts

Inflation

Inflation is like a hidden tax on all the money you have. It's when prices go up for goods and services across the economy. This can happen for different reasons, like when demand for products grows faster than their supply. Because of inflation, the same amount of money buys fewer things, reducing your purchasing power.
Inflation affects everyone, both individuals and governments. It's measured by calculating the percentage increase in a price index, like the Consumer Price Index (CPI).

• When inflation is high, your money doesn't stretch as far as it used to.
• A moderate inflation rate is expected in a growing economy.
• Deflation is when prices decrease over time, opposite to inflation but also potentially harmful to the economy.

Understanding inflation is crucial because it directly impacts saving, spending, and economic policies. When planning finances, keeping an eye on inflation rates can help make wiser decisions.

Money Wage

Money wage, often simply called 'wage,' is the amount of money paid to an employee before any deductions like taxes or benefits. Unlike the real wage, it doesn't consider the purchasing power or inflation.

• Money wage is straightforward: if your salary increases by 5%, your money wage rises by 5%.
• It reflects the nominal value, meaning the 'face value' of your earnings.
• Your money wage growth doesn't always mean you can buy more if inflation rates are high.

Money wages are frequently highlighted during salary negotiations or when comparing job offers. However, it's essential to think about what that wage can actually buy, considering current inflation rates.

Purchasing Power

Purchasing power is about how much your money can buy. It's not just about how much you earn but the real value of that money in terms of what it can buy.
When inflation rises faster than your wage, your purchasing power drops.

• Purchasing power decreases if prices rise but wages don't keep up.
• Your real wage is tied to purchasing power. It measures the wage value by considering inflation effects.
• To maintain purchasing power when prices rise, wages need to increase at the same or a faster rate than inflation.

Understanding purchasing power helps you plan better, ensuring that you save and invest wisely to maintain or increase your economic level.