Pigou Effect

AAA

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."

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects ...
  2. Equilibrium

    The state in which market supply and demand balance each other ...
  3. Inflation

    The rate at which the general level of prices for goods and services ...
  4. Deflation

    A general decline in prices, often caused by a reduction in the ...
  5. Aggregate Supply

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

    The total amount of goods and services demanded in the economy ...
RELATED FAQS
  1. What are the main risks to the economy of a country that has implemented a policy ...

    The main risk to the economy of a country that has implemented a policy of austerity is the potential for a self-reinforcing, ... Read Full Answer >>
  2. In what manner will a recession likely affect the marginal-propensity-to-save rate ...

    The marginal propensity to save, or MPS, rises in most, though not all, recessions. This makes perfect sense on an individual ... Read Full Answer >>
  3. Why would a country's gross domestic product (GDP) and gross national income (GNI) ...

    A country’s gross domestic product, or GDP, and gross national income, or GNI, are likely to differ considerably because ... Read Full Answer >>
  4. While closely related, how do gross domestic product (GDP) and gross national income ...

    Gross domestic product, or GDP, and gross national income, or GNI, are the two most important economic indicators that measure ... Read Full Answer >>
  5. How does the neoclassical growth theory predict real GDP?

    Neoclassical growth theory predicts real gross domestic product (GDP) through measures of total factor productivity, capital, ... Read Full Answer >>
  6. What do banks do to control the bank reserve?

    While all banks are required to maintain a specific amount of bank reserves, the banks themselves do not control the minimum ... Read Full Answer >>
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

    Is Texas The Future Of America?

    The top three fastest-growing cities are located in Texas and 20% of jobs created between 2009 and 2014 were in the Lone Star State.
  8. Economics

    Explaining Demographics

    Demographics is the study and categorization of people based on factors such as income level, education, gender, race, age, and employment.
  9. Economics

    The Most Likely Outcome For Greece

    After more than five years of a Greek drama, most of us have become fatigued with hearing about Greece’s debt problems, the one issue that won’t go away.
  10. Economics

    How Does a Company Use Raw Materials?

    Raw materials are the basic components of a finished product.

You May Also Like

Hot Definitions
  1. National Currency

    The currency or legal tender issued by a nation's central bank or monetary authority. The national currency of a nation is ...
  2. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  3. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  4. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  5. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  6. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
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!