A central concept of New Keynesian macroeconomics is that in setting prices and wages,self-interested firms and workers are acting
A)irrationally,since their self-interest is badly damaged by the ensuing business cycles.
B)irrationally,since this imposes business cycles on everyone not part of their arrangements.
C)rationally,since they do not bear a fully offsetting cost of business cycles.
D)rationally,since the total welfare loss of business cycles must be small enough to justify the price and wage setting.

Question

Quizplus · Accepted Answer

New Keynesian macroeconomics suggests that firms and workers act rationally in setting prices and wages, as they do not bear a fully offsetting cost of business cycles. In other words, while fluctuations in the economy hurt people's welfare, firms and workers do not bear the full cost of these fluctuations and therefore do not fully account for them in their decision-making. This creates a role for government intervention, such as monetary policy, to stabilize the economy and reduce the welfare costs of business cycles. Therefore, option C is the correct choice.

A Central Concept of New Keynesian Macroeconomics Is That in Setting