Do students understand inflation?

Abstract: Money illusion was for a long time believed by most economists to be non-existent, despite previous large support for it, because it did not fit the neo-classical model of the rational individual. Using a survey to test students’ understanding of inflation as proxy for money illusion, this thesis aims to establish the existence of money illusion and develop an understanding of why some students exhibit better understanding of inflation than others. Based on a sample of 275 university students, most of them on their first year, I find strong support for the hypothesis that students in general do not understand inflation beyond its definition. Knowing the definition of inflation is not enough to exhibit a deeper understanding. I find that studying economics or having previously taken courses in national economics at a university introductory level is not enough to significantly improve students’ understanding of inflation. My results also confirm the existence of money illusion in support of previous studies on the topic.