With rational expectations, a correctly anticipated policy that would increase AD would lead to:
A)higher inflation and lower unemployment in the short 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.

Question

With rational expectations, a correctly anticipated policy that would increase AD would lead to:
A)​higher inflation and lower unemployment in the short 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.

Quizplus · Accepted Answer

With rational expectations, if a policy that increases aggregate demand (AD) is correctly anticipated, people adjust their expectations accordingly. This means that workers and firms adjust their wage and price settings in anticipation of higher inflation, leading to an increase in inflation without affecting unemployment, as the economy adjusts without the surprise element that could temporarily lower unemployment.

With Rational Expectations, a Correctly Anticipated Policy That Would Increase