Answer to Question #48794 in Macroeconomics for dereje

Question

1. Differentiate between rational expectation and adaptive expectations?
2. What is the central tenet of the policy ineffectiveness hypothesis of the new classical proposition?
3. How changes in wealth shifts the consumption function?

Answer 1

1. Differentiate between rational expectation and adaptive expectations?
Rational expectations is a hypothesis in economics which states that agents' predictions of the future value of economically relevant variables are not systematically wrong in that all errors are random. Under adaptive expectations, expectations of the future value of an economic variable are based on past values.
2. What is the central tenet of the policy ineffectiveness hypothesis of the new classical proposition?
The policy-ineffectiveness proposition (PIP) is a new classical theory proposed in 1975 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations, which posits that monetary policy cannot systematically manage the levels of output and employment in the economy.
3. How changes in wealth shifts the consumption function?
Changes in financial wealth, as such, tend to cause consumption expenditures to change in the same direction.
- If households have more financial wealth, then they are able to buy more goods.
- If households have less financial wealth, then they are able to buy as fewer goods.