"Decision makers systematically err in their forecasts of economic variables." This is implied by which of the following:
Answer(s): B
According to the Adaptive Expectations hypothesis, people consider the recent past as the best predictor of the immediate future. Hence, when an economic variable is increasing, they will consistently tend to under-estimate the future value of that variable and vice versa. Thus, they systematically err in their decision-making, without learning from past mistakes.
Within the simple Keynesian model, when an economy operates below its long-run, full employment output constraint, an increase in aggregate demand will lead to an
Answer(s): D
Since according to the Keynesian model aggregate demand determines the level of output in the economy, an increase in the demand will cause output to increase. Since output is equivalent to income, real income also increases. The increase in output stimulates increases in labor demand and thus unemployment declines.Increases in aggregate demand below the full employment capacity of the economy has no effect on prices.
An economic researcher publishes evidence that the consensus inflation estimation for the following year has no correlation with the actual inflation level the year before. The estimation error is often very large, but does not display a pattern. Which of the following theories would this evidence support?
Answer(s): E
Under the rational expectations hypothesis, individuals will form inflation expectations based on all relevant information available. Therefore a comparison of expected and realized inflation would show a random estimation error and no correlation with past estimates. The adaptive expectations hypothesis suggests that individuals will base their views of the future on their recent experience.Under this theory, estimations would show a pattern in the error. Expected inflation would tend to be too high following a period of high inflation, and then too low follow a period of limited inflation.
During an economic boom, the AD-AS model indicates that
High demand for resources (like labor) during an economic boom will increase the price of labor (the real wage rate). Similarly high demand for loanable funds during a boom will cause the real interest rate to rise.
An economy is currently operating at full employment. If the Fed unexpectedly decreases the reserve requirement, in the short run, the aggregate output will ________. The unemployment will ________ the natural rate.
The unexpected decrease in the reserve requirement causes an unexpected expansion in money supply. In the short run, this leads to lower real interest rates. The increased availability of credit coupled with the rise in demand leads to an increase in real output and employment. Temporarily, the unemployment rate falls below the natural rate.
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