The wealth effect is influenced by changes in real wealth, impacting consumption choices based on perceived wealth rather than income levels.
The wealth effect differs from the income effect as it reflects changes in consumer choice based on perceived wealth, not actual income. For example, if a person owns a stock that appreciates in price, they may spend more, thinking they are wealthier. This effect is based on changes in real wealth rather than income. As the price level increases, the buying power of assets diminishes due to inflation, leading to a decrease in consumption spending.
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