The contribution of the rational expectations theory to the long-run model is the understanding that:
A the response of the public to policy changes makes the economy return to long-run equilibrium more quickly.
B the economy remains in short-run equilibrium longer.
C the long-run model can rarely be applied.
D economists must support the use of tax policy for long-run growth.
The correct answer and explanation is:
The correct answer is A: the response of the public to policy changes makes the economy return to long-run equilibrium more quickly.
Rational expectations theory suggests that individuals and businesses form their expectations about the future based on all available information, including the understanding of economic policies and potential changes. When the public anticipates a policy shift, they adjust their behavior accordingly, often in a way that reduces the effects of such policies on the economy in the long run.
In the context of the long-run model, rational expectations play a key role in how quickly an economy returns to its equilibrium after experiencing a shock or change in policy. According to the theory, if people expect that a policy change will occur, they will adjust their actions (such as consumption, investment, and labor supply) in anticipation, which helps to mitigate the short-term disruptions. This quicker adjustment leads to a faster return to long-run equilibrium.
For instance, if the government announces an expansionary fiscal policy, individuals and firms might expect inflation to rise. As a result, they may increase their prices and wages in advance, which can lead to higher inflation immediately. However, because people anticipate the effects of the policy, the economy adjusts more rapidly and returns to its long-term growth path.
In this way, the rational expectations theory contributes to the understanding that the economy does not experience long-term fluctuations caused by policy changes. Instead, economic agents respond in such a way that the economy stabilizes quickly, reinforcing the idea that the economy moves toward its long-run equilibrium more efficiently. This understanding is crucial for policymakers, as it implies that changes in policy may not have as lasting or significant effects as initially expected.