Question

58 in the video lectures on the Phillips, we presented two scenarios:

1 nominal wages rise by 3% and inflation rises by 3%

2 nominal wages rise by 3% and inflation rises by 5%

which of the following statements is correct?

Question 58 options:

a)	a scenario 1 causes real wages to rise ; scenario 2 causes real wages to fall

b)	b scenario 1 causes real wages to rise ; scenario 2 causes real wages to rise

c)	c scenario 1 causes no change in real wages ; scenario 2 causes real wages to fall

d)	d scenario 1 causes real wages to fall ; scenario 2 causes real wages to rise

Answer 1

Ans. Option c

Real Wage (R) = Nominal Wage(N) / Price level(P)

Applying natural log (ln) to both sides we get,

lnR = lnN - lnP

Differentiating whole equation with respect to time, t, we get,

%Change in R = %Change in N - %Change in P --->Eq1

[ln(A/B) = lnA - lnB, and d(lnA)/dt = dA/dt * 1/A = %Change in A over time t]

Scenario 1

%Change in Nominal Wage = 3%
%Change in price level = inflation = 3%
=> %Change in real Wage = 0% (From Eq1)

Scenario 2

%Change in Nominal Wage = 3%
%Change in Price level = Infation rate = 5%
=> %Change in real wage = -2% (From Eq2)

Thus, real wage does not change in scenario 1 but falls in scenario 2 by 2%.

* Please don’t forget to hit the thumbs up button, if you find the answer helpful.