Question

Your nominal wage increases 10%, and the overall price level increases 12%. Which statement is correct?

a)You can be certain your real wage increased.

b)You face a price confusion problem.

c)If you feel richer, you are experiencing money illusion.

d)You would experience deflation.

e)You face a menu costs problem.

Answer 1

Option

c)If you feel richer, you are experiencing money illusion.

a real increase in wage = nominal increase in wage - increase in the price level

=10-12

=-2%

the wages decrease by 2%

it means you can purchase less in a given income than you may purchase in the old income level.

But the money is more so you may think that your income is increased that is called money illusion because the income is not increased in the real term as the purchasing power is decreased.