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Wages

Nominal wages

The nominal wage is the wage per unit of time in the currency used in the country- what we typically just call wage. When we refer to wage in macroeconomics we almost always mean gross wage, that is, the wage before income taxes but after employment taxes paid by the employer. Wage is a flow that we typically measure in units of currency per hour.

Wages and Income

Remember that by wage we typically mean what you receive for working one hour, while income is the total revenue from all sources over a longer time period (such as a month). Your income depends on the wage but also on the number of hours you work. An individual may have a very high wage but a low income (say $1000 per hour but only working 1 hour per month) or a low wage but a high income (for example by owning stocks or bonds). Do not confuse wage with income.

Nominal wage level

In macroeconomics, we are normally not interested in the wage for a particular individual but in the average wage for all employed individuals. This average is called the wage level but since we typically only care about the wage level, we will almost always use wage when we actually mean the wage level. Thus, a statement such as "wages increase" should not be interpreted as all wages increasing, but rather that the average is increasing.

Real wage

Consider the following scenario. You work full time and during January 2008 you make 2000 euro after tax. A particular basket of goods and services costs 100 euro in January, which means that your salary will buy you 20 such baskets.

In February, you receive a 10% wage increase and you make 2200 euro after tax. Does this imply that you can buy 10% more baskets - that is 22 - in February? Well, not necessarily.

The number of baskets that you can buy in February depends on the possible changes in prices as well. If the price ofa basket increases by 3% to 103 euro your 2200 will buy you 2200/103 = 2l.36 baskets of 7% more than in January. Even though your wage has increased by 10%, you can only increase your consumption of baskets by 7%. We say that the real wage has increased by 7%.

Formally, we define the real wage as the nominal wage divided by a price index (typically CPI). In the example above, your real wage was 20 in January and 2l.36 in February if we use the price of the basket as a price index. Remember that the nominal wage will tell you your wage in units of currency, while the real wage will tell you your wage in baskets of goods and services and this is more important to us. Therefore, we care about increases in real wages, not in nominal wages. If you found out that Ken, who works in another country, got a 50% increase in his wage each year, you may initially be quite happy for Ken. If you then found out that inflation in the country where Ken works is 70%, you should actually feel sorry for him. His real wage is 1.5/1.7 = 88% of his real wage the year before - a real wage cut by 12%.

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