Question

Assume that is was reported in today’s newspaper that the rate of

inflation in Turkey over the past year has been 7.61%. Explain, using

simple numerical examples, what this could mean for the real wages of

Turkish workers.

Answer 1

Nominal wages are not adjusted for inflation which means when workers are paid nominal wages for a given expected inflation and suddenly actual inflation turns out to be much higher, then real wages which are nominal wages adjusted for inflation decline.

For example if a worker is contracted at $110 per hour then the nominal wage is $110. Employer is expecting and inflation of 10% which implies that real wage is 110/1.1 = $100. If inflation turns out to be 21% the real wages will be 110/1.21 = $91

This shows that real wages are actually reduced when there is an inflation in the economy. Generally employers expect a certain percentage of inflation when they determine the nominal wage. If inflation is greater than its expected value then real wages decline.