Money illusion is basically assuming money/wealth in nominal terms rather than considering its real value, which is inflation adjusted. Whatever money/wealth you have right now is the money in its nominal terms/value whereas the purchasing power of that money/wealth you have with you is its real value (inflation-adjusted). When people do not take into account the effects of inflation on their money, they are mistaken (or have the illusion) that their accumulated money/wealth is worth the same as in the previous year. This is termed as the 'money illusion'.
@@shikasworldofeconomics appreciate your time Mam. Thank you so much Could we derive Aggregate Supply by following the statement that " There is money illusion for economic agent".?
When consumers have money illusion, they tend to focus on the nominal value of their money/income. So when their nominal income increases, they think that they can purchase more goods, when in fact, they are not considering the impact of inflation. So, with such an illusion, consumers may demand more goods (increase in aggregate demand) which can have an impact on the aggregate supply in the short-run. But in the long-run, consumers will understand the inflation effects which will, again be reflected in the aggregate demand and supply.
