Real Wage: Definition & Formula

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  • 0:01 Definition of Real Wages
  • 1:00 Formula for Real Wages
  • 1:37 Example of Real Wage
  • 3:30 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Rising prices eat away at the value of your pay, and raises aren't always worth as much as you may think. In this lesson, you'll learn about real wages and how to calculate them. You'll also have a chance to take a short quiz after the lesson.

Definition of Real Wages

It's important to distinguish between nominal wages and real wages. If you are paid by the hour, you are paid a nominal wage, which is simply the amount of money that you earn per hour of labor. If you earn $20.00 per hour, your nominal wage is $20.00. However, the nominal wage really doesn't tell you what your purchasing power is because the nominal wage isn't adjusted for inflation, which is a rise in the general price level.

Your real wage, on the other hand, takes inflation into account. An increase in real wages occurs when wages rise more quickly than inflation. On the other hand, if real wages rise more slowly than inflation, then your real wages - your purchasing power - has declined. It's important for you to know your real wage to determine if an increase in your wage is actually increasing your wealth, simply keeping pace with rising costs, or worse, falling behind rising prices.

Formula for Real Wages

The formula to calculate a real wage is relatively simple. Let's see how we can do it with the consumer price index (CPI), which is readily available online from the U.S. Bureau of Labor and Statistics. The consumer price index is one of several indexes of consumer goods and services that keep track of changes in the price level. You can determine whether prices are rising or falling year over year by reviewing the numbers. You can use this formula, along with the CPI, to calculate real wages: Real Wage = (Old Wage * New CPI) / Old CPI

Example of Real Wage

Imagine that in 2010, your nominal wage was $18.00 per hour, and you received a two percent pay increase in 2011, making your nominal wage $18.36 per hour. The consumer price index for 2010, was 218.056 and in 2011 was 224.939. What was your real wage?

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