Question

When a person receives an increase in wealth, what is likely to happen to consumption and saving?

Answer 1

When a person receives an increase in wealth then the consumption increases and Savings decreases. This is related to the theory of "Wealth effect".

The wealth effect states that when the wealth of households rises, it results as rise in asset values, such as corporate stock prices or home values, they spend more and stimulate the broader economy.

The theory is dependent on economic behavior of a person that consumers feel more financially secure and confident about their wealth when their homes or investment increase in value. They are made to feel richer, even if their income and fixed costs are the same as before.

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