The prices consumers pay for goods and services and the amount of money they receive for performing work tend to change over time. The increase in the prices of goods and services in the economy is called inflation. In economics and finance, the term "real" describes a value that has been adjusted for inflation, while the term "nominal" is attributed to values that are not adjusted for inflation.
What Are Nominal Wages?
Nominal wages describe the dollar amount of wages earned without taking inflation into account. Nominal wages do not depend on costs in the economy and require no calculation. A nominal wage is simply the amount of money a person makes. For example, if your employer pays you wages of $3,000 a month, your nominal monthly wage is $3,000.
What Are Real Wages?
Real wages are the amount of income a person earns relative to some past date while correcting for the impact of inflation. Real wages provide insight into the actual purchasing power a worker has. The higher your real wages, the more goods and services you can buy with your income. Real wages only increase if nominal wages increase faster than the inflation rate. If prices increase faster than nominal wages, real wages will fall.
Purpose of Real Wages
The purpose of thinking about wages or any other values in "real" terms is to be able to compare them to past values in meaningful way. A worker today might earn a nominal income of $4,000 a month and a worker 100 years ago might have earned $2,000 a month, but these values don't tell you anything about how wealthy they are. If inflation caused prices to increase by 1,000 percent over the past 100 years, the worker with a $2,000 monthly income 100 years ago would have an income of $20,000 a month in terms of current dollars. In this case, correcting for inflation shows that the worker who earned $2,000 100 years ago could have purchased five times more goods and services than a present-day worker who earns $4,000.
Real wages earned by a given worker can fall over time even if nominal wages increase. For example, if you made $3,000 a month 10 years ago and earn $3,500 a month today, you earn $500 more in terms of nominal wages. If, however, you cannot purchase as many goods and services with $3,500 today as you could with $3,000 10 years ago because of increases in prices, your real wages have fallen.
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