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Wealth Effect - real income or wealth of a consumer...

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Wealth Effect: Professor A.C. Pigou had first stated and analyzed wealth effect under inflationary conditions of the price level changes. With a rise in the price level, value of the given money income of consumers (assuming supply of money to be constant) decreases. With a fall in the purchasing power of their income consumers become poorer and have to reduce their consumption. By way of an example a person with fixed money income of $100 can purchase 25 units of a commodity, price of the commodity being $4. But he can purchase only 20 units of the commodity when price rises to $5. Thus the
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Unformatted text preview: real income or wealth of a consumer diminishes from 25 to 20 even when his money income is constant. Such a wealth effect results in the consumer reducing his demand with a rising price level. Contrary would be the case under the conditions of deflation and falling prices. In that case his wealth effect will be positive and enable him to purchase larger quantities of all goods and services. Hence the presence of the wealth effect continues to maintain an inverse relation between price level changes and aggregate demand....
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