If consumers obey the permanent-income hypothesis and have rational expectations, then policy changes affect consumption when the policy changes:
A) are proposed.
B) go into effect.
C) change expectations.
D) do not surprise consumers.

Question

Quizplus · Accepted Answer

According to the permanent-income hypothesis and rational expectations, consumers base their consumption decisions not only on their current income but also on their expected future income. Therefore, policy changes will only affect consumption if they change consumers' expectations about their future income. This means that the correct answer is C, which states that policy changes affect consumption when they change expectations. A and B are incorrect because policy proposals or changes going into effect alone do not necessarily change expectations. D is also incorrect because consumers may still react to policy changes even if they are not surprised by them.

If Consumers Obey the Permanent-Income Hypothesis and Have Rational Expectations