Money Illusion

Many times people tend to forget about inflation when they think about prices.  They only take into account the nominal values and make their decisions on the basis of nominal dollar amounts rather than calculating in real money terms. Thus while income often stays the same products are exceedingly more expensive due to inflation. For example in the eurozone the inflation rate has been about 2 % in the last years.

This phenomenon is known as money illusion. Economists assume that if people acted more “rational”, price settings, wage contracts or even accounting methods would always be adjusted by indexation. But it appears that this is not always the case.

The phenomenon of money illusion has been discussed by economists in the last decades;

Irving Fisher illustrates in his book The Money Illusion(1928)how people make irrational decisions because they are unaware of the effects of inflation on their personal wealth.

John Maynard Keynes argues that smaller inflation rates of 1-2% p.a. can have positive effects for an economy. They make it possible for employers, to raise wages in nominal terms from time to time without actually paying more in real terms. Now people will think that their wealth is increasing because they got a pay-raise, without considering the actual rate of inflation.

Impact on financial markets

This phenomenon even influences our interpretation of stock curves. This slide depicts the difference between the nominal and the real prices for the Dow Jones Industrial Average. In the article on dshort.com (financial life cycle planning) it is described why there is a huge difference, especially during secular bear markets. In the nominal chart this period appears insignificantly short. But on the other hand, when we adjust for the inflation rate, there is a huge effect.( it is cascading downward direction of the real value of the market price).

This phenomenon has effects on the market decisions today. The interpretation of numbers that take into account inflation or not can have a huge effect on the expectations of the development of the stock market as Gordon T Long points out in his blog. He argues that financial advisers and traders always should be aware of money Illusion to make more adequate decisions.

What is anchoring and why it is important for your decision making

Have you ever made a really wrong decision and afterwards you were absolutely convinced that you should have known better? Here is a solution for to how analyzing you decision-making and maybe prevent some bias that our brain experiences.There are lots of situations in everyone’s life where you have to come up with big decisions.

Some people believe in determination or in a good that guides you, othertrust their intuition. But in the end we have to admit that many times our information is not enough to be able to make a competent decision. This blog post will give you an insight to what psychology found out about the human brain and its patterns of decision making. Furthermore I will point out why these patterns are immensely important to business and economics.

Monetizing news online

As writing a blog seems to be a concept of having a conversation with your readers about a specific topic, rather than being a one sided process “I speak you listen”, I will respond on the inspiring comments and the constructive critique I received.

Cognitive Biases- The Endowment Effect

What are Cognitive Biases and do they affect us?

After starting this program I realized that we all belong to the crowd of consumers that all companies want to get hold on. As in the 21 century people are said to be more individualized as before, there is a vast array of interests, demands and preferences. Modern capitalism is highly complex and developed strategies to make a profit from it.

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OK. That’s it. Sometimes no comment says more than a thousand words. That is exactly what happened to my blog (except one comment by Sonja who had mercy and I am really thankful). It still seems, after me trying to adjust a little, that my topic isn’t too targeted to the interest of my (not yet existing) reader.
So what I am going to do is writing about a topic that, I suppose interests everyone.
Dating

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How the most visited websites lead to Bandwagoning

I confess. I was about let you down and unscrupulously abandon the cognitive bias topic. I found it too academic and maybe a little too far away from what my crowd could be interested in. This post I decided should be more about curious and startling stuff rather than dull explanations of some freaky topic. I want to give you the possibility to learn in fast forward about a particular, exceptional topic, that you might even not know that you are curious about, all without having to read more than a page. And then there was the painful question of how the hell my topic would connect with business and IT, the subject this blog is supposed to be about?