Real Balance Effect

The Real Balance Effect occurs when changes in the price level influence consumers' purchasing power. If prices fall, the value of people's savings and assets increases in real terms, making them feel wealthier. This usually encourages more spending. Conversely, if prices rise, the real value of savings diminishes, leading to reduced spending. Essentially, it shows how fluctuations in overall prices can affect people's perception of their wealth and, consequently, their consumption behavior.