The term real wages
refers to wages that have been adjusted for inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. This term is used in contrast to nominal wages or unadjusted wages. Real wages provide a clearer representation of an individual's wages.
The use of adjusted figures is used in undertaking some forms of economic analysis. For example, in order to report on the relative economic successes of two nations, real wage figures are much more useful than nominal figures.
If nominal figures are used in an analysis, then statements may be incorrect. A report could state: 'Country A is becoming wealthier each year than Country B because its wage levels are rising by an average of $500 compared to $250 in Country B'. However, the conclusion that this statement draws could be false if the values used are not adjusted for inflation. An inflation rate of 100 percent in Country A will result in its citizens becoming rapidly poorer than those of Country B where inflation is only 2 percent. Taking inflation into account, the conclusion is quite different: 'Despite nominal wages in Country A rising faster than those in Country B, real wages are falling significantly as the currency halves in value each year'.
The importance of considering real wages also appears when looking at the history of a single country. If only nominal wages are considered, the conclusion has to be that people used to be a great deal poorer than today. The cost of living was also much lower. In order to have an accurate view of a nation's wealth in any given year, inflation has to be taken into account — and thus using real wages as the measuring stick.
Real wages are a useful economic measure, as opposed to nominal wages, which simply show the monetary value of wages in that year. However, real wages does not take into account other compensation like benefits or old age pensions.
Consider an example economy with the following wages over three years:
- Year 1: $20,000
- Year 2: $20,400
- Year 3: $20,808
Real Wage = W/P (W= wage, P= i, inflation, can also be subjugated as interest)
Also assume that the inflation in this economy is 2 percent p.a. These figures have very different meanings depending on whether they are real wages
or nominal wages
If the figures that are shown are real wages, then it can be determined that wages have increased by 2 percent after inflation has been taken into account. In effect, an individual making this wage actually has more money than the previous year.
However, if the figures that are shown are nominal wages then the wages are not really increasing at all. In absolute dollar amounts, an individual is bringing home more money each year, but the increases in inflation actually zeroes out the increases in their salary. Given that inflation is increasing at the same pace as wages, an individual cannot actually afford to increase their consumption
Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...