Within the aggregate demand-aggregate supply framework, a strict interpretation of rational expectations theory suggests that a change in aggregate:
A) Demand will have a large effect on the price level, but a small effect on output
B) Demand will have a small effect on the price level, but a large effect on output
C) Demand will have a large effect on the price level, but no effect on output
D) Supply will have a large effect on the price level, but no effect on output

Question

Quizplus · Accepted Answer

According to rational expectations theory, people adjust their expectations based on all available information, including current and future government policies. Therefore, any change in aggregate demand will already be factored into individuals' expectations and will result in a corresponding change in price level, but will not affect output in the long run as output is determined by the economy's potential output level.

Within the Aggregate Demand-Aggregate Supply Framework, a Strict Interpretation of Rational