Figure 15-3

-As shown in Figure 15-3,if people behave according to adaptive expectations theory,an increase in the aggregate demand curve from AD₁ to AD₂ will cause the economy to move

Question

Figure 15-3
 
-As shown in Figure 15-3,if people behave according to adaptive expectations theory,an increase in the aggregate demand curve from AD₁ to AD₂ will cause the economy to move

Quizplus · Accepted Answer

According to adaptive expectations theory, people adjust their expectations for inflation based on their past experience. When the aggregate demand curve shifts from AD₁ to AD₂, there is an initial increase in output and inflation from E₁ to E₂. However, as people update their expectations and realize that the increase in demand is only temporary, they will reduce their demand for labor and goods, causing the economy to eventually move to E₃ where output and inflation are lower than at E₁ but higher than at the initial equilibrium prior to the shift in AD. Therefore, the correct answer is D.

Figure 15-3 -As Shown in Figure 15-3,if People Behave According to Adaptive