What is wealth effect?

Wealth effect refers to a behavioral economic model that argues that human beings increase their consumption when their asset values rise. According to this economic model, people in an economy feel more confident when their asset value increases; thus, they are satisfied with their spending. When an individual is overconfident about something, he or she will spend more and save less. This concept can be applied to businesses to explain why firms increase their employee wages when their investment values increase. The idea can also be used to describe why the economy grows during the bull market and declines in the bear market.