The term “money illusion” refers to a tendency to think in terms of nominal rather than real monetary values. Money illusion has significant implications for economic theory, yet it implies a lack of rationality that is alien to economists. This paper reviews survey questions regarding people's reactions to variations in inflation and prices, designed to shed light on the psychology that underlies money illusion. We propose that people often think about economic transactions in both nominal and real terms, and that money illusion arises from an interaction between these representations, which results in a bias toward a nominal evaluation.

Myopic loss aversion is the combination of a greater sensitivity to losses than to gains and a tendency to evaluate outcomes frequently. Two implications of myopic loss aversion are tested experimentally. 1. Investors who display myopic loss aversion will be more willing to accept risks if they evaluate their investments less often. 2. If all payoffs are increased enough to eliminate losses, investors will accept more risk. In a task in which investors learn from experience, both predictions are supported. The investors who got the most frequent feedback (and thus the most information) took the least risk and earned the least money.