Money Illusion

CORE DEFINITION

In economics, money illusion, also known as money illusion, refers to the tendency of people to focus on the nominal value of money rather than its real value. In other words, the face value of money (nominal value) is often mistaken for its purchasing power (real value). Because of inflation, the real purchasing power of money changes over time, and the real purchasing power of money does not align with its nominal value, thus giving rise to money illusion. This hypothesis is used to argue against the neutrality of money. Money illusion arises because people only care about the quantity of money they receive, ignoring its real value. For example, when wages increase by 3% but inflation is 4% (prices rise by 4%), the nominal amount of money increases, making it seem like wages have risen, but considering the price increase, the real value of wages has actually decreased by 1%. When people feel that the money they receive has increased but ignore inflation (price increases), money illusion occurs. Economists argue that attention should be paid to the real value of money, not the nominal value, to avoid falling into money illusion. The Keynesian school believes that because of money illusion, even in deflation, workers are unwilling to accept nominal wage cuts, and wage rigidity leads to unemployment.