ShmoopTube

00:00

And finance Allah shmoop What are riel versus nominal wages

00:09

Well old Grandpa Larry has been retired for a while

00:12

so he's a bit out of touch When I was

00:14

your age burgers cost a quarter Now they're five dollars

00:18

five dollars Everything so expensive nowadays Oh Grandpa and guess

00:22

There he goes again being either sarcastic or totally not

00:26

getting that Inflation is a you know a thing Well

00:29

inflation is the reason prices and wages or nominal wages

00:32

to be precise there That's the reason they rise Inflation

00:36

Your nominal wage is the actual dollar amount on your

00:38

paycheck And on Grandpa you know when he a bad

00:41

one for you Maybe it's a three grand a month

00:43

for grandpa while it was three grand for the whole

00:46

year So grandpas not exactly wrong Everything was in fact

00:50

cheaper nominally cheaper back in the day But nominal incomes

00:54

were also lower Today the sticker price on everything is

00:57

much higher but so are our paychecks Where grandpa is

01:00

steered wrong is that well he's only thinking of prices

01:03

rising not income if prices rise But buying power also

01:07

rises Well then things aren't necessarily Mohr expensive or at

01:10

least not relatively more expensive What Grandpa doesn't get is

01:13

that he's looking at nominal wage rates when he should

01:16

be looking at the real wage rate Well the rial

01:19

wage rate is the money you make once you take

01:21

into account the effects of inflation on buying power While

01:24

your nominal paycheck is much larger than grandpas while you're

01:27

really wage rate might be pretty similar to what his

01:30

was in the nineteen fifties Riel wage rates allow us

01:33

to compare the amount of buying power different people have

01:36

or well had And that's what counts right Sure you

01:39

can buy a lot of things if you're a millionaire

01:41

today But as inflation raises prices for many decades down

01:45

the line being a quote millionaire unquote in nominal terms

01:49

it might be pretty average inflation which is what creates

01:51

the difference between nominal and real wages is the reason

01:55

you really really shouldn't save up cash in your sock

01:58

drawer under your match Chris was just sitting there doing

02:01

nothing You're much better off keeping your money somewhere where

02:04

it can at least gain a little interest income ideally

02:07

enough to keep up with inflation which is around two

02:09

or three percent a year on most years Think about

02:11

it this way If Grandpa Larry put a five dollar

02:14

bill in his sock drawer in the nineteen fifties that

02:16

five dollars was worth twenty burgers at the time right

02:19

A quarter a burger If he took out that same

02:22

five dollar bill from his sock drawer today he'd only

02:24

be able to buy one burger with it Just won

02:27

all that inflation over all those years Eroded the burger

02:30

buying value of that five dollar bill from twenty burgers

02:33

down to a single burger If you want to keep

02:35

your buying power up while the money you have lying

02:38

around needs to earn a two or three percent interest

02:40

a year if your nominal savings keeps up with inflation

02:44

while your riel savings will retain its riel buying power

02:48

If Grandpa Larry put that five dollars in the bank

02:51

accounts that yielded me let's call it two percent Well

02:53

then he'd be able to buy a lot more with

02:55

it than just one burger today Although he's not totally

02:58

wrong about burgers that is getting more expensive If you'd

03:01

put that five dollars in a bank account seventy years

03:04

ago and it grew a two percent a year well

03:06

at five dollars would now be twenty dollars which means

03:08

it grew three hundred percent of the price of burgers

03:11

though rose from a quarter to five dollars in the

03:14

same time which comes out Tio nineteen hundred percent well

03:18

While his five dollars was keeping up with inflation it

03:20

wasn't growing as fast as the cost of burgers So

03:23

the rial price of burgers actually did go up Even

03:27

on a relative basis The Consumer Price index helps us

03:29

see real price changes like these For instance the real

03:32

price of college and health care have risen by a

03:34

substantial amount way higher than the rate of inflation That

03:38

means it takes more buying power than it did before

03:40

to pay for those things which is a bigger cut

03:42

out of people's paychecks than ever before So maybe Grandpa

03:46

Larry is an entirely senile yet after all but he's

03:49

getting there

Full Transcript