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The term real wages refers to wages that have been adjusted for inflation. This term is used in contrast to nominal wages or unadjusted wages. Real wages provide a clearer representation of an individual's wages, but suffer the disadvantage of not being well defined, since the amount of inflation, based on different goods and services, is itself not well defined.
The use of adjusted figures is used in undertaking some forms of economic analysis. For example, to report on the relative economic successes of two nations, real wage figures are more useful than nominal figures. 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 significantly poorer than today. However, the cost of living was also much lower. To have an accurate view of a nation's wealth in any given year, inflation has to be taken into account and real wages must be used as the measuring stick.
An alternative is to look at how much time it took to earn enough money to buy various items in the past. Such an analysis shows that for most items, it takes much less work time to earn them now than it did decades ago, at least in the United States.
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% per year.
If the figures that are shown are real wages, then it can be determined that wages have increased by 2% 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.
- "Time Well Spent: The Declining Real Cost of Living in America" by W. Michael Cox and Richard Alm, pp. 2-24 of the 1997 Annual Report of the Federal Reserve Bank of Dallas.