Unit 1 The supply side of the macroeconomy: Unemployment and real wages

1.4 Measuring the macroeconomy: Nominal wages, prices, and real wages

The nominal wage

nominal wage

The actual amount received in payment for work, per unit of time, expressed in a particular currency. Also known as: money wage. See also: real wage.

The nominal wage can be defined as the actual amount of money per unit of time such as per hour or per year, in a given currency, received in payment for work.

As well as having a job, people care about the wage and more precisely what it can purchase. The person in charge of a household’s budget will often have a sense of the family’s nominal wage income and prices, and therefore also a sense of what can be purchased. Reflecting these concerns, three of the statistics often reported for the performance of an economy are the growth of nominal wages, prices, and real wages. These statistics refer to averages across the economy. The average for wages is often median weekly or monthly earnings, and for prices, the price of a representative basket of goods and services.

A useful device for comparing trends is to use index numbers. In this case, we are interested in comparing the evolution of nominal wages and prices over time to understand what is implied for real wages. By setting the value of each series equal to 100 in a base year, the relative growth over subsequent years can be easily compared.

Nominal wages are expressed in the currency of the country such as pesos, dollars, or rupees. They vary widely by occupation and industry. For this reason, wage statistics are aggregated to provide a macroeconomic indicator of average nominal wages. For example, the US Bureau of Labor Statistics reports the median weekly earnings for workers in the US aged 16 and older.

To construct the nominal wage index, we start by choosing a year as the baseline (in our case, 2010), and assigning it a value of 100. We then allow the index to measure changes to the nominal wage by converting the figures expressed in a given currency to index values relative to the baseline. For example, in 2010 the weekly nominal wage in the United States was $746—this is our baseline. In 2011, the nominal wage increased from $746 to $756 per week, a 1.3% rise. Therefore, if the nominal wage index is 100 in 2010, it will increase by 1.3% and reach \(\text{Nominal Wage Index} = 100 \times 1.013 = 101.3\) in 2011. The following year, wages increased to $768, a 1.6% increase from 2011. As such, the nominal wage index in 2012 will be \(101.3 \times 1.016 = 102.9\).

Figure 1.6 shows the nominal wage index for the US from 2010 to 2022.

The consumer price index

consumer price index (CPI)

A measure of the general level of prices that consumers have to pay for goods and services, including consumption taxes.

The consumer price index (CPI) is a metric that tracks the total price of a ‘shopping basket’ of goods and services commonly purchased by households, such as food, beverages, utilities, rent, healthcare, education, and financial services. An increase in the CPI represents an increase in the overall prices in the economy.

The consumer price index can be constructed in a similar way to the nominal wage index, by taking a baseline year and tracking the changes in the price level. Figure 1.7 shows the consumer price index for the US from 2010 to 2022.

The real wage

The real wage differs from the nominal wage by taking into account changes in prices across time. It measures the actual purchasing power that workers have from their earnings.

real wage

The wage expressed in terms of the amount of goods and services the worker can buy with it. It is calculated by dividing the nominal wage by the current price level in the same currency. See also: nominal wage.

We can now define the real wage more precisely. If your nominal wage (measured in pesos, euros, rupees, or the relevant local currency) is W per week, and the price of one unit of output measured in the same currency is P, then you can use your wage to buy W/P units of output each week. Your nominal wage depends on the currency used in the economy, whereas your real wage does not.

For a given year, a real wage index can be constructed by dividing the nominal wage index by the consumer price index and multiplying by 100:

\[\displaystyle\mbox{real wage index} = \displaystyle\left(\frac{\mbox{nominal wage index}}{\mbox{consumer price index}}\right)\times 100\]

Figure 1.8 shows the real wage index for the US between 2010 and 2022.

Figure 1.9 shows the three indices on the same plot.

Note that when the general increase in prices over time is larger than the nominal wage rise (as in the period between 2010 and 2014), workers will have a lower real wage than the baseline year. Conversely, as the nominal wage grows faster than prices, workers’ real wages will increase.

When the price level and the nominal wage have increased by the same amount after a period of time (as in 2015 in Figure 1.9), the real wage is at the same level as in the base year: the median worker earned approximately 8% more in 2015 than they did in 2010, but prices are also about 8% higher, so the purchasing power of their nominal wages is effectively the same.

The indices for nominal and real wages and consumer prices for the UK and Italy are shown in Figure 1.10.

Median weekly real wages fluctuated over the decade 2010–2019 in all three countries. The US ended the decade with a higher real wage than at the start of the decade, but in Italy and the UK in 2019, real wages were roughly the same level as in 2010. Italy experienced a particularly sharp decline in real wages following the pandemic.