Workers and firms are currently expecting the price level to ...

[yoooooman]

Workers and firms are currently expecting the price level to increase from 110 to 114. The Federal Reserve then announces that it will be reducing the growth rate of the money supply.
 
  If the Fed's announcement is credible, and firms and workers have rational expectations, describe how the expectations of firms and workers will be affected and how the change in expectations will affect the unemployment rate.

Question 2

Which of the following is a reason why increases in the price level result in a decline in aggregate expenditure?
 
  A) Price level increases in the United States relative to other countries raise net exports, which lowers aggregate expenditure.
  B) As the price level rises, government spending falls, which lowers aggregate expenditure.
  C) Price level increases cause firms and consumers to hold more money, which raises the interest rate. Higher interest rates lower consumption and planned investment expenditures, which lowers aggregate expenditure.
  D) Price level increases raise real wealth, which causes consumption spending and aggregate expenditure to decline.

[xMRAZ]

Answer to Question 1

Workers and firms were expecting an inflation rate of 3.6, but when the Fed announces it will be reducing the money supply, workers and firms rationally expect this will reduce inflation. Based on the expectation that inflation will fall, workers are willing to accept lower nominal wages and firms will pay lower nominal wages so that the real wage is unchanged. If the real wage is unchanged, the level of employment remains the same, and there is no impact on the unemployment rate.

Answer to Question 2

C

[yoooooman]

TYSM

[lindahyatt42]

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