Rational Expectations: Difference between revisions
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'''Phillip’s Curve''' | '''Phillip’s Curve'''[[Image:Unemployment.jpg|thumb|Description]] | ||
Using the Phillip’s Curve, rational expectations neutralize the monetary policy of the Central Bank by anticipating the increase of the money supply and shifting the curve upward from point 0 (π = 2) to point 1 (π = 4) as seen in the graph. | Using the Phillip’s Curve, rational expectations neutralize the monetary policy of the Central Bank by anticipating the increase of the money supply and shifting the curve upward from point 0 (π = 2) to point 1 (π = 4) as seen in the graph. | ||
'''AS/AD Relationship''' | '''AS/AD Relationship'''[[Image:AD Relationship.jpg|thumb|Description]] | ||
In the AS/AD relationship, the Central Bank increases the money supply causing AD to shift to the right, but with rational expectations, people change their price expectations causing a simultaneous shift in the AS curve leftward keeping output at the natural level. The result of the increase in the money supply with rational expectations causes a higher price level at the same level of output. | In the AS/AD relationship, the Central Bank increases the money supply causing AD to shift to the right, but with rational expectations, people change their price expectations causing a simultaneous shift in the AS curve leftward keeping output at the natural level. The result of the increase in the money supply with rational expectations causes a higher price level at the same level of output. | ||
Revision as of 01:32, 26 April 2007
What is Rational Expectations?
Rational expectations in theory is the idea that the public will anticipate the monetary changes of the Central Bank and thus, change the prices and wages proportionately to counteract the monetary policy of the Central Bank. In doing this, the public shifts the price level so that output and employment remain at their natural levels respectively making the monetary policy neutral. There are two assumptions of rational expectations:
- People are rational and have rational economic expectations
- These people’s expectations supercede that of most wage and price takers and setters
Effects of Rational Expectations using the Phillip’s Curve and the AS/AD Relationship
Phillip’s Curve
Using the Phillip’s Curve, rational expectations neutralize the monetary policy of the Central Bank by anticipating the increase of the money supply and shifting the curve upward from point 0 (π = 2) to point 1 (π = 4) as seen in the graph.
AS/AD Relationship
In the AS/AD relationship, the Central Bank increases the money supply causing AD to shift to the right, but with rational expectations, people change their price expectations causing a simultaneous shift in the AS curve leftward keeping output at the natural level. The result of the increase in the money supply with rational expectations causes a higher price level at the same level of output.
The Missing Motivations in Macroeconomics | Ricardian Equivalence | Dependence of Consumption on Wealth, not Income | The Modigliani-Miller Theorem | Natural Rate Theory
