With rational expectations, a correctly anticipated policy that would increase AD would lead to:
A)higher inflation and lower unemployment in the long run.
B)higher inflation and higher unemployment in the short run.
C)higher inflation and no change in unemployment in the short run.
D)lower inflation and lower unemployment in the short run.
E)higher inflation and higher unemployment in the long run.

Question

Quizplus · Accepted Answer

Rational expectations assume that individuals have accurate information about economic policies and their expected outcomes. As a result, if a policy that will increase aggregate demand (AD) is correctly anticipated, individuals will adjust their behavior to reflect this knowledge. This means that prices and wages will adjust accordingly, leading to higher inflation in the short run. However, because there is no change in the underlying structure of the economy, unemployment will remain unchanged in the short run. In the long run, prices and wages will fully adjust, leading to higher inflation and no change in the natural rate of unemployment.

With Rational Expectations, a Correctly Anticipated Policy That Would Increase