What is the effect of inflation on real wages and purchasing power?

• A. Real wages rise, purchasing power increases.
• B. Real wages fall, purchasing power declines.
• C. Purchasing power remains the same.
• D. Inflation does not affect wages.

Answer: (B)

Inflation makes prices higher, so what you can buy with your money depends on how your wages move with those prices. Real wages are your nominal wages adjusted for inflation, and purchasing power is how much you can actually buy with that money. If prices rise and your pay doesn’t increase at the same pace, your real wages fall and you can buy less—your purchasing power declines. For example, if your wage stays the same but prices go up 3%, you effectively lose about 3% of your buying power. Only if wages keep up with or exceed inflation would real wages stay the same or rise. The idea here is that inflation erodes what money can buy unless wages adjust accordingly, so the typical outcome is real wages falling and purchasing power declining.