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NBER WORKING PAPER SERIES HOUSING WEALTH AND

What is the wealth effect theory?
What is The Wealth Effect? The wealth effect is a behavioral economic theory suggesting that people spend more as the value of their assets rise.
The idea is that consumers feel more financially secure and confident about their wealth when their homes or investment portfolios increase in value.
Is the wealth effect the same as the income effect?
It differs from the income effect in the sense that only perception regarding wealth changes of the asset holders due to the Wealth-Effect.
In contrast, the income effect increases income and purchasing power and affects all persons with or without assets.
What is an example of the wealth effect?
Demand for some goods (called inferior goods) decreases with increasing wealth.
For example, consider consumption of cheap fast food versus steak.
As someone becomes wealthier, their demand for cheap fast food is likely to decrease, and their demand for more expensive steak may increase.
The response of consumption to unexpected changes in wealth is referred to as the 'wealth effect'.
Wealth effects can occur for a number of reasons. 'Traditional' wealth effects occur because, when wealth unexpectedly increases, households have more resources to support consumption over their lifetime.

What is the wealth effect theory?