Principles of Economics- Mankiw (5th) 614

Principles of Economics- Mankiw (5th) 614 - 634 PA R T T E...

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634 PART TEN MONEY AND PRICES IN THE LONG RUN therefore, are nominal variables. For instance, when we say that the price of corn is $2 a bushel or that the price of wheat is $1 a bushel, both prices are nominal vari- ables. But what about a relative price—the price of one thing compared to another? In our example, we could say that the price of a bushel of corn is two bushels of wheat. Notice that this relative price is no longer measured in terms of money. When comparing the prices of any two goods, the dollar signs cancel, and the re- sulting number is measured in physical units. The lesson is that dollar prices are nominal variables, whereas relative prices are real variables. This lesson has several important applications. For instance, the real wage (the dollar wage adjusted for inflation) is a real variable because it measures the rate at which the economy exchanges goods and services for each unit of labor. Similarly, the real interest rate (the nominal interest rate adjusted for inflation) is a real vari-
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