Wealth Effect

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  • Otherwise known as the real balance effect. When prices change, individuals become richer or poorer depending on the direction of price movements. The value of their assets (money, bonds, and other financial assets) increases or decre ases as a result of changes in the purchasing power of their assets—that is, what their assets can buy in real or actual units.

    When the price level falls, the assets of individuals and businesses increase, because they can purchase more (wealth effect appreciates). On the contrary, when the price level increases, the purchasing power of financial assets falls, thereby resulting in a depreciation of the value of wealth. The wealth effect has an impact on spending and investment. A declining wealth effect causes a reduction in spending and conversion ...

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