# Why does the real wage = W/P?

Im reading about labour markets, and the notes mention that the real wage 'w' = W/P, where W = the nominal wage, and P = the price level. Could someone please use some 'W' and 'P' as an example to show me how real wages emerge from the ratio W/P?

Thanks!

Whenever we go from nominal to real terms, we need a base year. As an example, let's use 2016 as the base year. In the base year, the nominal wage $W$ is always equal to the real wage $w$ (this is true for any price or cost, not just wage). Also, we always set the price level $P$ equal to 1 in the base year. That's what makes it the base year.

Anyway, let's say that, in 2016, $w_{2016}=W_{2016}=15$. Suppose that, between 2016 and 2017, there's 2% inflation - that is, the price level $P$ increases by 2% from $P_{2016}=1$ to $P_{2017}=1.02$. Then, it follows that the real wage in 2017 will be $w_{2017}=\frac{W_{2016}}{P_{2017}}=\frac{15}{1.02}=14.706$. I hope this example helped.

In case it didn't, you can think about it like this: Dividing the nominal wage by the price level is just how you adjust for inflation, thus giving you the real wage.

• Awesome! I figured that the price level actually might of meant a price index, not just some random number. Thanks so much for your help! Aug 5 '16 at 4:09

I think it should be noted that any real price, in this case wage, is actually the price of something in units of a good. In this case, P the price level is the price of a typical consumed basket of goods. The real wage W/P is how much you are paid in "baskets". Economists care about real prices because nominal prices are in units of money, which is just paper, but real prices tell you how many goods you can get. The idea is you don't care about the money, what you care about is the goods you can buy with the money.

For example, imagine the price of a pizza is \$10/pizza. And you earn \$20/hour. Then your real wage W/P = (\$20/hour)/(\$10/pizza) = 2 pizzas / hour. You get paid 2 pizzas an hour.