Legal Definitions - real wages

Real wages refer to the actual purchasing power of the money an individual earns, rather than just the numerical amount of their salary or hourly pay. It measures how much goods and services a person can buy with their earnings, taking into account changes in the cost of living due to inflation. When inflation rises, the same amount of money buys less, meaning real wages decrease unless nominal wages increase at an even faster rate. Conversely, if inflation falls or nominal wages rise significantly faster than inflation, real wages increase.

• Example 1: Inflation outpaces a pay raise
  An office administrator receives a 3% pay raise, increasing their annual salary from $50,000 to $51,500. However, during the same year, the inflation rate is 4.5%. Although the administrator's nominal salary increased by $1,500, the cost of living (prices for groceries, housing, fuel, etc.) rose by 4.5%. This means that their 3% pay raise does not keep pace with the 4.5% increase in prices. In terms of what they can actually buy with their earnings, their purchasing power has effectively decreased. Therefore, their real wages have fallen, even though their nominal wages went up.

• Example 2: Stable nominal wages with decreasing inflation
  A factory worker's hourly wage remains constant at $20 per hour for two consecutive years. In the first year, the inflation rate was 3%. In the second year, the inflation rate dropped to 0.5%. In the first year, the worker's $20 per hour was eroded by 3% inflation, meaning their purchasing power was less than the nominal amount suggests. In the second year, even though their nominal wage didn't change, the significantly lower inflation rate of 0.5% means that their money can now buy relatively more goods and services than it could in the previous year. Consequently, their real wages have increased because the cost of living has risen at a much slower pace, enhancing their purchasing power.

• Example 3: Comparing purchasing power over time
  A software developer earned $70,000 annually in 2005. Today, in 2024, they earn $100,000 annually. To understand if they are truly better off, one must consider the cumulative inflation over those 19 years. If the cost of living has increased by more than 43% (the percentage increase from $70,000 to $100,000) during that period, then despite the higher nominal salary, their real wages might actually be lower, meaning their current salary buys less than their 2005 salary did. Conversely, if inflation was less than 43%, their real wages have increased.