Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Courses
  • Find a Job
  • Home
  • Economics, Finance, & Analytics
  • Economic Analysis & Monetary Policy

Pigou Effect - Explained

What is the Pigou Effect?

Written by Jason Gordon

Updated at April 25th, 2022

Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Marketing, Advertising, Sales & PR
    Principles of Marketing Sales Advertising Public Relations SEO, Social Media, Direct Marketing
  • Accounting, Taxation, and Reporting
    Managerial & Financial Accounting & Reporting Business Taxation
  • Professionalism & Career Development
  • Law, Transactions, & Risk Management
    Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
  • Business Management & Operations
    Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior
  • Economics, Finance, & Analytics
    Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles
  • Courses
+ More

Table of Contents

What is the Pigou Effect?How does the Pigou Effect Work?Pigou's Hypothesis and Liquidity TrapPigou Effect Criticism Academic Research on the Pigou Effect

What is the Pigou Effect?

Pigou effect is an economic term referring to the relationship between employment, wealth, consumption, and output during the deflation period. According to the Pigou effect, when there is price deflation, the output (employment) increases due to a rise in wealth. That is, if wealth, is defined as the money supply divided by the levels of the current price. Alternatively, price inflation, output, and employment will go down as a result of a decrease in consumption.

Back to:ECONOMIC ANALYSIS & MONETARY POLICY

How does the Pigou Effect Work?

The term Pigou effect was given by Don Patinkin in the year 1948, naming it after an anti-Keynesian economist, Arthur Cecil Pigou. Another term for the Pigou effect is the real balance effect. Pigou argued against Keyness theory stating that it was not enough when it comes to specifying a link from real balances to the existing consumption. His argument was that wealth effect was capable of making the economy more self-correcting to decrease in aggregate demand than what was predicted by Keynes.

Pigou's Hypothesis and Liquidity Trap

An economy that is in the form of a liquid trap cannot make use of the monetary stimulus to increase output. The reason is that there is little link between money demand and personal income. According to John Hicks thinking, this could be another reason for the persistently high rate of unemployment. Nonetheless, the Pigou Effect has been able to create a mechanism for evading the trap. As unemployment goes up, the price level drops hence increasing real balance causing the consumption to rise. At full employment, the economy will move to a new environment. A conclusion by Pigou was that if wages and prices become sticky, then there will be equilibrium with the employment rate falling below the full employment rate, also known as the classical natural rate. 

Pigou Effect Criticism 

Michal Lalaecki criticized Pigou's effects. He argued that the required adjustment would result in an increase in the debts real value and also lead to a confidence crisis and wholesale bankruptcy.

Related Topics

  • Deflation
  • Pigou Effect
  • Basket of Goods and Services
  • Base Year
  • Indexing and Index Number
  • Cost of Living Allowance
  • Adjustable Rate Mortgage
  • Fisher Effect



pigou effect

Was this article helpful?

Yes
No

Related Articles

  • Fisher's Separation Theorem - Explained
  • Paradox of Thrift - Explained
  • Nominal Gross Domestic Product - Explained
  • Network Externalities - Explained



©2011-2023. The Business Professor, LLC.
  • Privacy

  • Questions

Definition by Author

0
0
Expand