THE MONEY ILLUSION (from wiki) In economics, money illusion, or price illusion,

THE MONEY ILLUSION
(from wiki)

In economics, money illusion, or price illusion, is the tendency of people to think of currency in nominal, rather than real, terms.

In other words, the face value (nominal value) of money is mistaken for its purchasing power (real value) at a previous point in time. Viewing purchasing power as measured by the nominal value is false, as modern fiat currencies have no intrinsic value and their real value depends purely on the price level.

Money illusion influences economic behaviour in three main ways:

Price stickiness. Money illusion has been proposed as one reason why nominal prices are slow to change even where inflation has caused real prices or costs to rise.

Contracts and laws are not indexed to inflation as frequently as one would rationally expect.

Social discourse, in formal media and more generally, reflects some confusion about real and nominal value.

Money illusion can also influence people’s perceptions of outcomes. Experiments have shown that people generally perceive an approximate 2% cut in nominal income with no change in monetary value as unfair, but see a 2% rise in nominal income where there is 4% inflation as fair, despite them being almost rational equivalents. This result is consistent with the ‘Myopic Loss Aversion theory’.[4] Furthermore, the money illusion means nominal changes in price can influence demand even if real prices have remained constant.[5]