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What Are Real Wages in Economics?

When you compare wages from different periods of time, for example across decades, inflation must be taken into account.

Theory

Real Wages

Your real wages measures your purchasing power as a consumer. That means it’s a measure of the quantity of goods and services your wages can buy for you.

\begin{array}{l} Real wages & = wages \cdot currency value \\ = wages \cdot \frac{100}{CPI} \end{array}

Real wages = wages \cdot currency value = wages \cdot \frac{100}{CPI}

Example 1

Donald Duck earned $$ 32 000$ in 2010. If the CPI was $128.8$ in 2010, what were his real wages that year?

First, you have to find the currency value for 2010. In this case, that’s the value of the dollar.

\begin{array}{l} Dollar value 2010 & = \frac{100}{CPI 2010} \\ = \frac{100}{128.8} \\ \approx 0.78 \end{array}

Then you can find the real wages like this:

Real wages 2010 = 32 000 \cdot 0.78 = 24 960 .

We find out that Donald Duck’s real wages were $ $24 960$ in 2010.

Example 2

Mr. Duck received a $1.5 %$ raise in 2011. How much did his real wages increase from 2010 to 2011 when the CPI was $130.4$ in 2011?

First, you need to find the wages for 2011, so we can compare them to the wages of 2010.

Wages 2011 = 32 000 \cdot 1.015 = 32 480

You get the number $1.015$ by converting the $1.5$ % raise into a growth factor.

Next you need to find the dollar value of Mr. Duck’s 2011 wages. Then you can use the formula for real wages.

\begin{array}{l} Dollar value 2011 & = \frac{100}{CPI 2011} = \frac{100}{130.4} \\ \approx 0.77 \end{array}

Dollar value 2011 = \frac{100}{CPI 2011} = \frac{100}{130.4} \approx 0.77

This means that his real wages in 2011 were

\begin{array}{l} Real wages 2011 & = 32 480 \cdot 0.77 \\ = 25 009.6 \end{array}

Real wages 2011 = 32 480 \cdot 0.77 = 25 009.6

Now, you can find the percentage-wise increase of his real wages by using the formula for percentage change:

\begin{array}{l} \frac{Real wages 2011 - real wages 2010}{Real wages 2010} \\ = \frac{25 009.6 - 24 960}{24 960} \\ = 0.0020 \\ = 0.2 % \end{array}

\begin{array}{l} \frac{Real wages 2011 - real wages 2010}{Real wages 2010} & = \frac{25 009.6 - 24 960}{24 960} \\ = 0.0020 \\ = 0.2 % \end{array}

Even though Donald’s wages increased by

1.5

% from 2010 to 2011, his real wages, and therefore also his purchasing power, only increased by

0.2

%. That’s not much at all!

Note! During salary negotiations, real wages are the important thing. That’s what actually decides how much your own personal economic situation will improve. It might be smart to let Uncle Scrooge take care of salary negotiations in the future.

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