Rational expectations theory asserts that because people have rational expectations, if a policy of reducing the money supply is used:
A) it might affect both AD and potential real GDP.
B) consumers and firms observe that the money supply has fallen, anticipate the eventual reduction in the price level, and adjust their expectations accordingly.
C) participants in economic activity react in such a way that shifts in aggregate supply will reinforce shifts in aggregate demand, and real GDP will shift inevitably into inflationary or recessionary gaps.
D) periods of unemployment will be very short.

Question

Quizplus · Accepted Answer

Rational expectations theory asserts that consumers and firms will adjust their expectations accordingly if the money supply is reduced. This means that they will anticipate the eventual reduction in the price level, which will affect aggregate demand. Therefore, the correct answer is (B) - consumers and firms observe that the money supply has fallen, anticipate the eventual reduction in the price level, and adjust their expectations accordingly.

Rational Expectations Theory Asserts That Because People Have Rational Expectations