Suppose the Bank of Canada has a target inflation rate of 3%,always hits its target,and the inflation rate has been 3% for several years.Furthermore,assume Amazon sets the price of its Kindle Fire at $140 in 2012 and wants to keep the real price of the Kindle constant in order to maximize profits.Now suppose that the Bank of Canada announces on January 1,2013 that it will decrease its target rate for inflation to 1%.If Amazon has adaptive expectations,it will set its price for the Kindle in 2013 at
A) $137.20.
B) $140.00.
C) $141.40.
D) $144.20.

Question

Quizplus · Accepted Answer

With adaptive expectations, Amazon would expect the inflation rate to remain at 3% and would increase the price by 3% to maintain the real price, resulting in a price of $144.20.

Suppose the Bank of Canada Has a Target Inflation Rate