Question 1

A vocal minority of economists, believers in the theory of rational expectations, insist that

Accepted Answer

The theory of rational expectations asserts that people form their expectations about future inflation based on all available information, including past and current policy actions. As a result, the short-run Phillips curve is vertical, implying that there is no trade-off between inflation and unemployment in the short run. This is because any attempt to reduce unemployment through expansionary policies would be anticipated by workers and firms, leading them to demand higher wages and prices, which in turn would raise inflation without lowering unemployment. In the long run, according to the theory of rational expectations, the Phillips curve is also vertical, meaning that monetary and fiscal policies cannot permanently reduce unemployment below its natural rate and can only lead to higher inflation.

Question 2

If inflationary expectations are quite sluggish (that is, they do not adapt quickly), then the short-run Phillips curve will

Accepted Answer

The answer of If inflationary expectations are quite sluggish (that...

Question 3

Based on the evidence, most economists believe that the self-correcting mechanism operates

Accepted Answer

The answer of Based on the evidence, most economists believe...

Question 4

If workers always see inflation coming, and if they demand wage increases in advance so that inflation does not erode real wages, then the economy's aggregate supply curve on the AD-AS diagram will

Accepted Answer

If workers always see inflation coming and demand wage increases in advance, firms will also increase their prices in anticipation of higher labor costs. As a result, the short-run aggregate supply (SRAS) curve will shift upward, and the economy will experience higher inflation along with higher output. In the long run, however, wages and prices will adjust fully to changes in the money supply or other shocks, and the SRAS curve will return to its original position at potential GDP, making the aggregate supply curve a vertical line. Therefore, the economy's aggregate supply curve on the AD-AS diagram will be a vertical line corresponding to potential GDP.

Question 5

According to the theory of rational expectations, the government can influence output

Accepted Answer

According to the theory of rational expectations, individuals form their expectations about the future based on all available information, including the government's policy actions. Therefore, if the government makes expected changes in aggregate demand, individuals will adjust their behavior accordingly, and output will not be affected. However, if the government makes unexpected changes in aggregate demand, individuals may be slow to adjust their expectations, leading to a temporary impact on output. Thus, the government can only influence output by making unexpected changes in aggregate demand.

Question 6

The theory of rational expectations says that

Accepted Answer

The theory of rational expectations states that individuals will make the best possible forecasts of future events based on all available information, including past experience and knowledge. In the case of inflation, workers would use all available information about economic conditions and monetary policy to make the most accurate forecast possible.

Question 7

If workers and firms forecast inflation accurately,

Accepted Answer

The answer of If workers and firms forecast inflation accurately,
...

Question 8

If workers expect inflation, and negotiate wage increases that exactly match price increases, the result is a

Accepted Answer

If workers negotiate wage increases that exactly match price increases, there would be no change in the overall cost of production for firms. As a result, the aggregate supply curve would be vertical. This occurs because potential GDP is determined by the economy's resources and technology, not by the price level.

Question 9

If employees and employers always accurately predict inflation, what is the shape of the Phillips curve?

Accepted Answer

If employees and employers always accurately predict inflation, then they will adjust their expectations accordingly, and there will be no tradeoff between inflation and unemployment. As a result, the Phillips curve will be vertical, indicating that there is no relationship between unemployment and inflation. This is true both in the short and long run.

Question 10

What will tend to happen to wages if workers and employers foresee inflation?

Accepted Answer

If workers and employers anticipate inflation, they will negotiate for higher nominal wages to maintain their real wages (purchasing power). Therefore, nominal wages will increase by an amount that keeps real wages constant.

Question 11

If workers expect inflation, and tend to overestimate actual inflation when they negotiate wage increases, the result will be a continuing

Accepted Answer

The answer of If workers expect inflation, and tend to...

Question 12

Rational expectations are forecasts

Accepted Answer

Rational expectations are based on the best available information, but they may not always be completely accurate. They are made by individuals who use all available information in order to make the best possible prediction about future economic conditions.

Question 13

If actual inflation differs from expected inflation, what is the slope of the aggregate supply curve?

Accepted Answer

In the short run, the aggregate supply curve is upward sloping because firms cannot immediately adjust their input prices in response to changes in the price level. However, in the long run, firms can adjust their input prices which leads to a vertical aggregate supply curve. If actual inflation differs from expected inflation, it will cause firms to adjust their input prices differently in the short run than they would have expected, leading to a change in output and prices in the short run. This implies that the upward sloping aggregate supply curve will shift due to changes in actual inflation from expected inflation. However, in the long run, firms will adjust their input prices to reflect the new level of inflation, leading to a return to potential output and a vertical aggregate supply curve.

Question 14

If the self-correcting mechanism operates quickly,

Accepted Answer

If the self-correcting mechanism operates quickly, it means that the economy will naturally correct itself and move back to equilibrium without the need for direct intervention. This is because prices and wages will adjust, and the market will clear. Therefore, direct intervention is less necessary to close a recessionary gap, making option A the correct choice.

Question 15

If workers demand wage compensation in advance of inflation, the economy's aggregate supply curve will

Accepted Answer

If workers demand wage compensation in advance of inflation, it creates a situation where the costs of production for firms increase even when there is no increase in demand. This will cause the aggregate supply curve to shift vertically upward, leading to a decrease in output and an increase in price level. Therefore, the aggregate supply curve becomes vertical.

Question 16

Many economists think that, in the long run, the economy tends to move toward

Accepted Answer

The natural or full-employment rate of unemployment is the lowest rate at which inflation is stable, and the economy is producing at its potential output. Over time, the economy tends to move toward this rate as it adjusts to changes in labor market conditions and other factors that affect employment.

Question 17

If expectations are rational,

Accepted Answer

Rational expectations imply that on average, people correctly anticipate inflation rates, meaning any difference between actual and expected inflation rates would be random and not systematically predictable.

Question 18

Many economists think that, in the long run, the Phillips curve is

Accepted Answer

In the long run, the Phillips curve is a vertical line because there is no stable trade-off between inflation and unemployment. In the long run, changes in the money supply only affect nominal variables and not real variables like unemployment, so the Phillips curve is essentially flat at the natural rate of unemployment, resulting in a vertical line.

Question 19

If actual inflation differs from expected inflation, what is the slope of the Phillips curve?

Accepted Answer

The answer of If actual inflation differs from expected inflation,...

Question 20

If workers underestimate inflation, the aggregate supply curve will tend to be

Accepted Answer

If workers underestimate inflation, they will be willing to supply more goods and services at the prevailing price level, which means that the short-run aggregate supply curve will shift to the right, resulting in an upward sloping aggregate supply curve.

Quiz 34: The Trade-Off between Inflation and Unemployment