Polls / November 18, 2011

Do you know what the “money illusion” is and why it is important for managing money?

The term “money illusion” is known by about a third of respondents to the eZonomics online poll, while the remainder are not so sure.

Back in my day…
If you’ve heard someone reminisce about what large amount a dollar could buy decades ago, give them your congratulations. These people are thinking about the purchasing power – or the “real value” – of money rather than the face value. They may be less likely to be fooled by money illusion.

Money illusion is the tendency of people to think of money in nominal terms rather than how much it can buy. As an eZonomics article explaining money illusion in detail says, the phenomenon is firmly based in reality despite the “supernatural-sounding title”.

Thanks boss?
The money illusion might strike when negotiating a pay rise. Let’s say the boss is proposing a two percent rise; it might sound like a nice little increase. But what if inflation is high and running at four percent? Under these conditions, the next year’s wage won’t go as far as last year’s. The real value – or purchasing power – of the money could well actually decrease by 2%. So instead of increasing spending or saving plans, it might be necessary to trim them.

It is similar to the difficulties that travellers can have calculating how much they are spending when holidaying in a country that uses a different currency to their own. It might pay to think not only of the face value of money but how far it can go.

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eZonomics team
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