Inflation and Real Wages
There is a pretty common myth about inflation. The myth goes that during times of inflation a workers purchasing power drops. This is said to happen because prices inflate (the cost of goods and services rise) and workers have to spend more to maintain
the same standard of living. This is not really the case. During periods of inflation workers raises generally rise at the same rate as inflation since they are, essentially, a price for a service. So although prices have risen, wages have risen and the same portion of a workers income is used to purchase the same amount of goods.
The parity between prices and inflation is known as something different altogether. Historically there have been periods where wages raise faster than the price of goods and periods when the price of goods raises faster than wages. The gap between these to rates is called the real wage rate. Now I know your asking yourself why this gap changes when I just told you that wages are prices and they should change at the same rate. This is a general rule of thumb but there are several factors that increase or decrease wages that do not always affect the cost of goods, such as automation and increased output per worker. If each worker can make more of the same thing for the same cost as before the worker can make more but the product will be priced the same.
Now in discussing the real wage rate there is a way to calculate a workers real wage. Their real wage is not how many dollars per hour they earn, but rather the amount of purchasing power they earn per hour (how much can they get for working that hour). To calculate this you must first take the consumer price index (the CPI). The CPI is an index of price which monitors the rise and fall of prices year by year. So by looking at the rise or fall in prices using the CPI from a base year until the current year, and wages from the same time frame we can calculate the real purchasing power of those wages. For example if workers wages rose ten percent over five years and the price index rose ten percent also we would be able to figure out that the workers purchasing power has not changed at all.
Most people don’t look at this logically as they review their own wage increases. Most workers want to assume that they had earned their raises and view inflation as a separate entity which is taking extra money away from them. This is not
always true, many annual raises are considered cost of living raises. These are raises which are basically meant to keep a worker at the same purchasing power as they have been, and are not really meant to increase their earnings.
- by James Strahn | AC
-- rahel
