Economics Study Set 17

Answer:

Effect of rise in expected inflation on wage rate
Increase in inflation rate reduces the real wage (nominal wage divided by inflation). A rise in price level reduces the purchasing power of the consumer; this means that the same amount of income will enable purchase of less amount of commodity.
The expectation of rise in rate of inflation will reduce the real income of the labor in future. Hence, to equalize the income to the rise in price level, labor will bargain for a higher wage rate.

Answer:

Meaning of rational expectation
Rational expectation is the use of all relevant available information to forecast the rate of inflation. Hence, predictor will not commit any systematic error.
No systematic error
Rational expectation has a stunning application in economic policy because it does not believe in committing any systematic error.
Recession cannot be shut out by expanding aggregate demand
Rational expectation believes that recession cannot be shut out by expanding aggregate demand. A predictable change in demand will change the expected rate of inflation; hence, output will remained unaffected.
Aggregate demand will not change the unexpected rate of inflation
Rational expectation believes that an anticipated change in aggregate demand will not change the unexpected change in rate of inflation. Hence, rational expectation theory do not want to fight inflation by reducing aggregate demand.

Answer:

It is said that the Federal Reserve Board cares more about inflation and less about unemployment than administration.
Reason for the president's worries about the interest rates
The change in rate of interest will change the level of investment as well as demand side of an economy. A faster economic growth can be achieved by regulating rate of interest.
Since interest rate is a key variable in determining economic growth, the president often worries to change the interest rates when the president wants.