Post by ¯\_(ツ)_/¯ on May 13, 2016 13:45:03 GMT
Imagine an economy at the natural level of output. When there is a permanent decrease in government spending in the AS-AD model there will be a inward shift of the AD curve. The AS curve will then slowly shift out as the price level is below the expected price level decreasing the real money stock therefore the interest rate and hence output will increase again. In this way the economy will return to the natural level of output.
1. Under Rational expectations (RE) if the change in government spending was announced the shift of AS and AD will be simultaneous and the economy will stay at the natural level of output
2. Under RE if the government did not announce this the economy will temporarily be below the natural level and then quickly return
3. Under adaptive expectations if phi is 0 the economy will never return to the natural output level as the price level will consistently be incorrectly anticipated never changing the money stock
4. The larger phi the faster the economy will return to the natural level as the expectations will change faster.
Is this a correct understanding of how Adaptive and Rational Expectations work in AS-AD ? If not what is wrong and what is right ?
1. Under Rational expectations (RE) if the change in government spending was announced the shift of AS and AD will be simultaneous and the economy will stay at the natural level of output
2. Under RE if the government did not announce this the economy will temporarily be below the natural level and then quickly return
3. Under adaptive expectations if phi is 0 the economy will never return to the natural output level as the price level will consistently be incorrectly anticipated never changing the money stock
4. The larger phi the faster the economy will return to the natural level as the expectations will change faster.
Is this a correct understanding of how Adaptive and Rational Expectations work in AS-AD ? If not what is wrong and what is right ?
