Money illusion and the market

  • Tyran J
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Imagine a consumer who discovers to his surprise that the money in his bank account and his salary have doubled overnight. Now suppose that all prices have also doubled overnight. Will this consumer be happy about being awash with money? Will he feel richer today and buy more or different goods than he did yesterday? Not according to standard eco- nomic theory. After all, he has to work the same number of minutes to buy, say, a loaf of bread, and can therefore afford to buy exactly the same set of goods as he did yesterday. In short, the boost in purely “nominal” terms (which inflates all mon- etary values by the same factor) should not affect behavior because nothing has changed in “real” terms (i.e. when taking this inflation properly into account)

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  • Jean-Robert Tyran

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