Homework Question on Nominal and Real Wages
- Given that: Demand for labor, DDL = MPL * P Wage, w = MPL * P Suppose an economy produces 2 goods, Food and Cloth, using labor and land in Food sector; labor and capital in Cloth sector. If the price of Cloth, PC, increases by 10% but the price of Food, PF, remains unchanged, what is the effect on the incomes of the following groups in the economy
- Workers [Be sure to include the concepts of nominal and real wages in your explanation; 2.5 points]
- Owners of Capital [Base on your answer on profits to owners of capital; 2.5 points]
- Owners of Land [Examine the impact on landowners’ income and purchasing power; 2.5 points]
- What would have been the effect on the incomes of workers, owners of capital, and landowners if relative price of Cloth had decreased [No maths. Use your intuition; 2.5 points].
Homework Answer on Nominal and Real Wages
If the price of cloths (PC) increases, people will tend to buy less clothing hence the quantity demanded decreases. In the meantime, the quantity demanded for food increases due to increased prices of cloths. This affects peoples` income in the market such as the workers, owners of capital, and owners of land. Incomes for workers in the clothing industry will be adjusted to cater for inflation. This means that the workers/employees will be paid real wages. It is because of the fact that the industry experiences general decrease in demand for its products.
On the other hand, workers in the food industry will be entitled to nominal wages because prices of farm products remain unchanged while quantity demanded rises.Owners of capital benefit from increased demand for money as a results of increased demand for food. It affects the quantity supplied in the market while prices remain the same. Therefore, income for capital owners is quite high.
However, capital owner’s experiences reduction in money demand in case the prices of clothing rises hence entitled to lower incomes. The reason behind this is that traders will shy away from borrowing money hence lowering their incomes. Lastly, landowners’ incomes are expected to rise with increase in the prices of farm produce. This goes hand in hand with the increase in the cost of input products for farmers.