Which of the following is an example of money illusion assuming that inflation is 5%?
A) You receive a 5% raise at your part-time job and start spending extra money on entertainment every weekend.
B) You receive a 5% raise at your part-time job but do not increase or decrease your spending.
C) You do not receive a raise at your part-time job but cut out some expenses as you notice some prices rising.
D) You receive a 10% raise at your part-time job and start spending extra money on entertainment every weekend.

Question

Quizplus · Accepted Answer

Money illusion occurs when people mistake nominal changes for real changes. In this case, the 5% raise is nominal and does not account for inflation. Therefore, assuming that prices have gone up by 5%, the increase in income is actually only keeping up with inflation and not providing any real increase in purchasing power. By increasing spending on entertainment without adjusting for inflation, the person is experiencing money illusion.

Which of the Following Is an Example of Money Illusion