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Money Illusion

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  • Eldar Shafir
  • Peter Diamond
  • Amos Tversky

Abstract

The term "money illusion" refers to a tendency to think in terms of nominal rather than real monetary values. Money illusion has significant implications for economic theory, yet it implies a lack of rationality that is alien to economists. This paper reviews survey questions regarding people's reactions to variations in inflation and prices, designed to shed light on the psychology that underlies money illusion. We propose that people often think about economic transactions in both nominal and real terms, and that money illusion arises from an interaction between these representations, which results in a bias toward a nominal evaluation.

Suggested Citation

  • Eldar Shafir & Peter Diamond & Amos Tversky, 1997. "Money Illusion," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 341-374.
  • Handle: RePEc:oup:qjecon:v:112:y:1997:i:2:p:341-374.
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    File URL: http://hdl.handle.net/10.1162/003355397555208
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    References listed on IDEAS

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    1. Shepard, Andrea, 1991. "Price Discrimination and Retail Configuration," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 30-53, February.
    2. Reagan, Patricia B. & Weitzman, Martin L., 1982. "Asymmetries in price and quantity adjustments by the competitive firm," Journal of Economic Theory, Elsevier, vol. 27(2), pages 410-420, August.
    3. West, Kenneth D, 1988. "Asymptotic Normality, When Regressors Have a Unit Root," Econometrica, Econometric Society, vol. 56(6), pages 1397-1417, November.
    4. Severin Borenstein, 1991. "Selling Costs and Switching Costs: Explaining Retail Gasoline Margins," RAND Journal of Economics, The RAND Corporation, vol. 22(3), pages 354-369, Autumn.
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