Wealth Effect

The wealth effect is a psychological phenomenon that causes people to spend more as the value of their assets rises.

The premise is that when consumers’ homes or investment portfolios increase in value, they feel more financially secure, so they increase their spending.

Conversely, when consumers see the value of their homes or portfolios fall, they tend to spend less. The wealth effect attempts to explain why consumers might change their spending habits even if their income and fixed costs have stayed the same.

Changes in aggregate demand caused by change in the value of assets such as stocks, bonds, gold, property. Increase in the market value of these assets induces a feeling of being 'richer' in their owners (even if no additional cash is realized) and often tends to encourage spending and to dampen savings.