If consumers obey the permanent-income hypothesis and have rational expectations, then ______ policy changes influence consumption.
A) only unexpected
B) only expected
C) both expected and unexpected
D) neither expected nor unexpected

Question

Quizplus · Accepted Answer

According to the permanent-income hypothesis and rational expectations, consumers base their consumption decisions on their expected long-term income. Therefore, only unexpected changes in policy (such as unexpected tax cuts or increases in government spending) are likely to influence consumption in the short term, as they affect consumers' immediate disposable income. Expected policy changes, on the other hand, are already incorporated into consumers' long-term income expectations and are unlikely to have a significant impact on their current consumption decisions.

If Consumers Obey the Permanent-Income Hypothesis and Have Rational Expectations