Ever heard people say “ Back in our time, things were so cheap and now they are unreasonably costly”. This claim is true but why does this happen?
One of the reasons for this is inflation. Inflation refers to the general rise in the prices of all goods and services.
Now let's say your salary increases by 10% in the last 5 Years. A common man takes the nominal value of this increase and thinks that he/she is better off than before. Hence, falling for the money illusion.
To comprehend money illusion accurately, we first need to understand the term “Nominal Value” of money.
So, what is a nominal value?
Nominal Value refers to the unadjusted rate or current price of the currency, without taking inflation into account. This means that just because one's salary increases, it does not mean one is better off than yesterday. This is because the inflation in the economy increases simultaneously, resulting in an increase in prices of everything else.
Simply put, the ₹100 yesterday could buy you more goods and services than ₹100 today.
But a common man fails to realise this and thinks they are better off when in reality it doesn't make any difference.
This phenomenon is called money illusion.
Money illusion is an economic theory proposing that people tend to view their wealth and income in nominal currency terms, rather than in real terms. In other words, it is assumed that people do not take into account the level of inflation in an economy, wrongly believing that a dollar is worth the same as it was the prior year.
This edition of econSHOT is proofread by Elizabeth Annie Sleeba. The thumbnail art is designed by Alana Biju.
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