Wealth effect:

The wealth effect describes the tendency for people to spend more when they perceive their wealth increasing, and less when they perceive it decreasing. This perception of increased wealth is often driven by rising asset values, such as stocks or real estate, even if those assets haven’t been sold. The wealth effect can influence economic activity by impacting consumer spending and aggregate demand.

Defining Wealth Effect:
The wealth effect is a behavioral economic phenomenon where people’s spending habits are influenced by their perception of their net worth, which is the value of their assets minus their liabilities.
How it works:
When individuals perceive their wealth increasing, due to rising stock prices, property values, or other asset values, they tend to spend more, believing they have more disposable income. This increased spending can lead to higher aggregate demand in the economy. Conversely, if individuals perceive their wealth decreasing, they may spend less, potentially leading to slower economic growth.
Examples:
Stock market boom: If the stock market rises significantly, individuals who own stocks may feel wealthier, even if they haven’t sold their shares. This perceived wealth increase can lead them to spend more on goods and services.
Housing market boom: Similarly, if housing prices increase, homeowners may feel wealthier, leading to increased spending, especially on home improvements or renovations.
Impact on the economy:
The wealth effect can significantly impact macroeconomic variables like consumer spending, aggregate demand, and economic growth. It’s an important factor to consider when analyzing economic trends and forecasting.
Limitations:
The wealth effect is not always a direct or consistent relationship. Factors like household debt, income levels, and individual spending habits can also influence consumption.