Chapter 15, Problem 5MCQ

To determine

The question requires us to determine the impact of the increase in wage and consumer price index on real wages.

Explanation of Solution

Real income will fall from year 1 to year 2 when wages doubled and the price index increases from 100 to 300.

An increase in price causes the purchasing power of money to fall, but the simultaneous increase in income level may compensate for the higher price partially or completely, and the individual remains unaffected.

  $\text{Real wage = }\frac{\text{Nominal wage}}{\text{Change}\text{in}\text{price}}$

Suppose, the price index in year 1 = 100,

Price index in year 2 = 300

Wage in year 1 = $10,000

Wage in year 2 = $20,000 (double of year 1)

  $\begin{array}{c}\text{Real wage in year 1 = }\frac{\text{\$10,000}}{\text{100}}\\ \text{=\$100}\\ \text{Real wage in year 2 = }\frac{\text{\$20,000}}{\text{300}}\\ \text{=\$66}\text{.66}\end{array}$

So, real wages will fall.

Option “b” is correct.