intelligenteconomist.com
INTELLIGENT ECONOMIST


Macroeconomics
MACROECONOMICS
The Pigou Effect
Prateek Agarwal
August 04, 2017
Table Of Contents
Pigou Effect Definition
The Pigou effect is an economics term that refers to the stimulation of output and employment. Increasing consumption causes this because of a rise in real balances of wealth, particularly during deflation.
Arthur Cecil Pigou defined real wealth as the sum of the money supply and government bonds divided by the price level. He argued that Keynes’ General Theory was not enough in not specifying a link from “real balances” to current consumption. He stated that the inclusion of such a “wealth effect” would make the economy more ‘self-correcting’ to drops in aggregate demand than Keynes predicted.
Pigou’s Hypothesis and The Liquidity Trap
An economy in a liquidity trap cannot use monetary stimulus to increase output because there is little connection between personal income and money demand. John Hicks thought that this might be another reason (along with sticky prices) for persistently high unemployment. However, the Pigou Effect creates a mechanism for the economy to escape the trap:
As unemployment rises the price level drops which raises real balances and thus consumption rises.
Finally, the economy moves to the new equilibrium, at full employment. Pigou concluded that an equilibrium with employment below the full employment rate (the classical natural rate) could only occur if prices and wages were sticky.
Kalecki’s Criticism of the Pigou Effect
The Pigou effect was criticized by Michał Kalecki. The adjustment required would increase the real value of debts, and would consequently lead to wholesale bankruptcy and a confidence crisis.
Prateek Agarwal
Member since 20 June, 2011
Prateek Agarwal’s passion for economics began during his undergrad career at USC, where he studied economics and business. He started Intelligent Economist in 2011 as a way of teaching current and fellow students about the intricacies of the subject. Since then he has researched the field extensively and has published over 200 articles.
Read More
Share this post
Leave a comment
Your email address will not be published. Required fields are marked *
Related Articles
MACROECONOMICS
Marginal Revenue
Marginal Revenue (MR) is the increase in the Total Revenue (TR) that is gained when the firm sells one additional (marginal) unit of that product. In other words, MR is the revenue obtained from the last unit sold.
Prateek Agarwal
July 30, 2018
MACROECONOMICS
Stagflation
Stagflation is an unusual economic situation in which high inflation (leading to increasing prices) coincides with increasing unemployment rates and decreasing levels of output/stagnation of economic growth. That’s why it’s called “stagflation”.
Prateek Agarwal
February 14, 2020
MACROECONOMICS
Circular Flow Model
The circular flow of income is illustrated in the circular flow model of the economy, which is one of the most significant basic models within economics. This model shows how different units in an economy interact, breaking things down in a highly simplified manner.
Prateek Agarwal
August 05, 2019
INTELLIGENT ECONOMIST
© 2021 - Intelligent Economist. All Rights Reserved.