The Rational Expectations Theory States That When Individuals and Firms

question 31

Multiple Choice

The rational expectations theory states that when individuals and firms make decisions, they take everything into account. Thus:

• A) if it's clear that the government intends to trade off higher inflation for lower unemployment, the public will understand this and help the government achieve its goal.
• B) if it's clear that the government intends to trade off higher inflation for lower unemployment, the public will understand this and inflation expectations will immediately rise.
• C) a government attempt to trade off higher inflation for lower unemployment would not work in the short run but would be fine in the long run.
• D) even if people are not expecting inflation and are unaware of government policies, inflation expectations are still going to be embedded.

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