Use the table below to choose the correct answer.
According to the adaptive expectations hypothesis, at the beginning of period 3, decision makers would expect inflation during period 3 to be

Question

Use the table below to choose the correct answer. 
According to the adaptive expectations hypothesis, at the beginning of period 3, decision makers would expect inflation during period 3 to be

Quizplus · Accepted Answer

According to the adaptive expectations hypothesis, decision makers base their expectation of the current inflation rate on past inflation rates. At the beginning of period 3, decision makers would have experienced inflation rates of 2.5 percent in period 1 and 5 percent in period 2. Therefore, they would expect inflation during period 3 to be the average of the past two periods, which is (2.5 + 5)/2 = 3.75 percent. However, they may round this up to 4 percent or down to 3.5 percent. The closest option is B) 5 percent, which is a reasonable expectation based on the past inflation rates.

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