Wednesday, December 23, 2015

Nominal vs. Real (Wages, Income)

Nominal vs. Real (wages, income)

To understand Nominal and Real we must first understand the concepts of Inflation and Purchasing Power

Inflation is an increase in the average price level of goods and services in a nation over time.
(If the price of apples is increasing, and the reason is because of a flood or a drought, then this is not spoken of as inflation as the cause is specifically from a flood/draught) If the price of all goods in the country are rising then we have Inflation. (Often caused by increases in the supply of a country's currency)

Purchasing Power is the number of goods or services that can be purchased with a unit of currency.

Nominal wages = current wages    

Nominal wages (Income) is the amount of money I am paid at a certain period of time.  If I'm paid $12 an hour, then my nominal wage is $12 dollars and hour. A nominal wage is expressed in the country's currency.  If apples cost $1 each, then I have the ability (purchasing power) to buy 12 apples. 

Time Passes, (let's say a year) and Inflation occurs, Apples have risen in prices to $2 each. 

I'm in the US and my wage is $12 an hour, that is my nominal wage (income), and the purchasing power of my nominal wage is 6 apples at a cost of $2 each. Due to inflation my hourly wage of $12 has been reduced. I use to be able to purchase 12 apples for an hour's work but now I can only buy 6. My purchasing power has been reduced by 50%.

Real Wage = (purchasing power of wages, what it will buy, nominal wages adjusted for inflation)

  • If your income stays the same and inflation (price level rises) occurs,  then your real wage has decreases. 
  • If your income stays the same and instead of inflation there is deflation (price level falls), then your real wage has increased.
  • If your income stays the same and there is no inflation, then your real wage is your nominal wage

Nominal Wages = Real Wages  (if there is no inflation = 0%)
If your wage (income) is $12 an hour, and there is no inflation (price level=no change) then $12 is your real wage.

Real Wages = Nominal Wages - Inflation
If your nominal wage is $12 an hour and inflation is 50% then your real wage would be equal to $6 an hour. A 50% increase in inflation will cause ones real wage to be 50% lower than the nominal wage.
So, lets look at this 2010 problem. If the workers nominal wage increased from $10 to $12 then the wage increased by 20%. Yet, at the same time inflation (price level) increased by 10%.

So, wages increased by 20% and inflation increased by 10%.

IF you gain 20% and inflation (eats) ten of that 20%, you are left with 10%, the answer is C.

Nominal Wages = Real Wages (Inflation = 0%)
                                                               $10 = $10

Real Wages = Nominal Wages - Inflation
                $9 = $10 - $1 (Inflation increased by 10%, this equals $1 of a $10 wage)

Real Wages = Nominal Wages - Inflation
                $8 = $10 - $2 (Inflation increased by 20%, this equals $2 of a $10 wage)

Real Income video - mjmfoodie

Saturday, December 12, 2015

2004 AP Micro FRQ#1

This was a tough one. College Board, "You bastards"

2004 AP Micro FRQ#1 

My Understanding:

Answer from the college board 

As MSC > than MPC, the externality is a negative production externality.

At a quantity of Q2, MSB = MSC at a price of $12.

The government can incentivise the monopolist to produce more by providing a subsidy. A subsidy should be provided to the point where the monopolists MC (MPC) curve will be reduced until it intersects with the MR (MPB) curve at Q2 (social optimal quantity)

A Perfectly competitive firm would produce an overproduction of a negative production externality. Its market price is where MPC = MPB and this is at the price of $7 and at a quantity of Q3. To get the perfectly competitive firm to produce less a per-unit tax must be levied against the (industry). As the firm has no control over price (price-takers) the industry must have the tax imposed upon it. At a tax of $5 the price would rise to $12 and the quantity would be reduced to Q2. Or what I believe to be the socially optimal quantity and price.

Students were asking why the government would subsidise a monopoly to create more negative goods,,, I believe the answer is to recognise that even a negative production externality has a benefit to society. Pollution might be the problem,, but no pollution means no production and this would be much worse than the externality. So government recognises that there is a benefit in the production of the good. 

Understand that the marginal benefit should equal the marginal cost. (MB = MC) or the MSC = MSB.

We could spend trillions of dollars to clean all of the rivers and lakes but then the MSC > MSB. Society would have pristinely clean rivers but not much of anything else.

Thank you Michelle for bringing this to my attention,,

Such fun I've had today,, trying to figure this out.