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Exhibit: Economic Adjustments
-(Exhibit: Economic Adjustments)
Suppose the economy is at point a.Assume that (1)
The public's expectations are completely rational; (2)
Markets allocate resources instantaneously; and (3)
The economy is at its natural level of employment.The theoretical adjustment path resulting from an increase in aggregate demand according to the rational expectations hypothesis is
A)a to c to d.
B)a to b to d.
C)a to d.
D)a to b and back to a.

Question

Use the following to answer questions 
Exhibit: Economic Adjustments 
-(Exhibit: Economic Adjustments)
Suppose the economy is at point a.Assume that (1)
The public's expectations are completely rational; (2)
Markets allocate resources instantaneously; and (3)
The economy is at its natural level of employment.The theoretical adjustment path resulting from an increase in aggregate demand according to the rational expectations hypothesis is
A)a to c to d. 
B)a to b to d. 
C)a to d. 
D)a to b and back to a.

Quizplus · Accepted Answer

Given the assumptions of rational expectations, instant market adjustments, and the economy being at its natural level of employment, an increase in aggregate demand would lead directly to an increase in the price level without affecting output in the long run. This is represented by a direct move from point a to point d, as output remains at its natural level and only prices adjust.

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