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True or False:  If the actual rate of inflation is lower than expected inflation, then...

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lilylee | Student, College Freshman | Salutatorian

Posted July 25, 2013 at 2:20 PM via web

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True or False:  If the actual rate of inflation is lower than expected inflation, then the actual real wage is higher than the expected real wage. This being the case, firms will lay off workers.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted July 26, 2013 at 2:00 AM (Answer #1)

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This statement is true.  All other things being equal, businesses will be more likely to lay workers off in this situation.

When workers expect a certain level of inflation, they will want their wages to increase to match that level.  Let us imagine that workers and firms expect inflation to run at 4%.  The workers therefore get a 4% raise.  If, however, inflation is only 2%, the workers real wages will go up.  The workers and the firms actually expected that the workers real wages would stay steady because their wages would go up exactly as much as inflation did.  However, if their wages went up more than inflation did, they will actually experience an increase in real wages.

If the workers’ real wages increase, firms will be more likely to lay them off, all other things being equal.  If workers do not create any more value than they previously did, the firms will not want to pay them more than they previously did.  If the firms are forced to pay workers more, they are more likely to lay them off so that their real costs do not rise relative to their revenues.  Therefore, this statement is true.

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