Pigou Effect


DEFINITION of 'Pigou Effect'

A term in economics referring to the relationship between consumption, wealth, employment and output during periods of deflation. Defining wealth as the money supply divided by current price levels, the Pigou effect states that when there is deflation of prices, employment (and thus output) will be increased due to an increase in wealth (and thus consumption).

Alternatively, with the inflation of prices, employment and output will be decreased, due to a decrease in consumption.

Also known as the "real balance effect."

BREAKING DOWN 'Pigou Effect'

Arthur Pigou, for whom this effect was named, argued against Keynesian economic theory by professing that periods of deflation due to a drop in aggregate demand would be more self-correcting. The deflation would cause an increase in wealth, causing expenditures to rise, and thus correcting the drop in demand.

  1. Inflation

    The rate at which the general level of prices for goods and services ...
  2. Keynesian Economics

    An economic theory of total spending in the economy and its effects ...
  3. Deflation

    A general decline in prices, often caused by a reduction in the ...
  4. Aggregate Demand

    The total amount of goods and services demanded in the economy ...
  5. Aggregate Supply

    The total supply of goods and services produced within an economy ...
  6. Equilibrium

    The state in which market supply and demand balance each other ...
Related Articles
  1. Economics

    Economics Basics

    Learn economics principles such as the relationship of supply and demand, elasticity, utility, and more!
  2. Economics

    What Is Fiscal Policy?

    Learn how governments adjust taxes and spending to moderate the economy.
  3. Economics

    Understanding Supply-Side Economics

    Does the amount of goods and services produced set the pace for economic growth? Here are the arguments.
  4. Personal Finance

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  5. Options & Futures

    Explaining The World Through Macroeconomic Analysis

    From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone.
  6. Options & Futures

    Gauging Major Turns With Psychology

    Knowing what the market is thinking is the best way to determine what it will do next.
  7. Economics

    Why the Euro Failed to Become the World's Reserve Currency

    Examine the current state of the U.S. dollar as the world's reserve currency; learn the major reasons why the euro has failed to replace it in that capacity.
  8. Economics

    These Will Be the World's Top Economies in 2020

    Discover the current economic forces that are anticipated to significantly shift the landscape of the world's most powerful economies over the next decade.
  9. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  10. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  1. Is Japan an emerging market economy?

    Japan is not an emerging market economy. Emerging market economies are characterized by low per capita incomes, poor infrastructure ... Read Full Answer >>
  2. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>
  3. Which is more important to a nation's economy, the balance of trade or the balance ...

    There is no question the composition of a country's balance of payments is more important than its balance of trade. This ... Read Full Answer >>
  4. What are the ethical arguments against government subsidies to companies like Tesla?

    The ethical argument behind government subsidies is that they should be put into place to help industries that will, in turn, ... Read Full Answer >>
  5. How can tariffs cause inefficiencies in domestic industries?

    Any government regulation naturally creates inefficiencies in a pure supply and demand marketplace. When it comes to the ... Read Full Answer >>
  6. How do changes in interest rates affect the spending habits in the economy?

    Changes in interest rates can have different effects on consumer spending habits depending on a number of factors, including ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  2. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  3. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  4. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  5. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  6. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!