Suppose you are forced to take a pay cut of 5% when the economy is experiencing overall deflation of 5%.If in response to your pay cut you also reduce your consumption by 5%,then economists would say:
A) you made a rational decision.
B) you are exhibiting money illusion.
C) your real wage decreased by 5%.
D) the quantity theory of money held.

Question

Quizplus · Accepted Answer

By reducing consumption in response to the pay cut, you are exhibiting money illusion - a tendency for people to confuse nominal monetary values (such as wages or prices) with real values (which take into account changes in the purchasing power of money). In reality, your real wage has decreased by 5% due to the combination of the pay cut and deflation.

Suppose You Are Forced to Take a Pay Cut of 5