Rational expectations- inflation unemployment trade-off , Microeconomics

Rational Expectations- Inflation Unemployment Trade-off:

Now, consider what happens if we suppose that workers have rational expectations about the rate of inflation First, this implies that, depends on information available to workers in any period t denoted by I(t), it is possible to define an objective probability distribution for the rate of inflation in the economy in period t + 1. Thus, there exists a conditional probability density function.

The rational expectation hypothesis then implies that 

712_Rational Expectations- Inflation Unemployment Trade-off.png

235_Rational Expectations- Inflation Unemployment Trade-off 1.png

suppose ε(t+1) presents the deviation of the actual rate of inflation

939_Rational Expectations- Inflation Unemployment Trade-off 3.png

Suppose we consider the conditional probability distribution of the prediction error for the rate of inflation in period t+1, ε(t+1),  , given that the set of' information I(t) is available in period t. If, workers do not make systematic errors in prediction, like I consistently predicting a value higher than the actual or a value lower than the actual, 1 then for a sufficiently large number of predictions based on the same information set, the average error in prediction must be zero.

Thus, if workers have rational expectations about the rate of inflation, the expected rate of inflation of workers can never consistently underestimate the actual rate of Inflation. In fact, over the long run, the sum of positive prediction errors for workers 1must be equal to the sum of negative prediction errors.

Posted Date: 11/21/2012 8:18:44 AM | Location : United States

Related Discussions:- Rational expectations- inflation unemployment trade-off , Assignment Help, Ask Question on Rational expectations- inflation unemployment trade-off , Get Answer, Expert's Help, Rational expectations- inflation unemployment trade-off Discussions

Write discussion on Rational expectations- inflation unemployment trade-off
Your posts are moderated
Related Questions
Non-existence of Objective Probability Distributions :   Let us see why expectations are volatile in nature? According to Keynes (1936, pp. 149): "Our knowledge of the fact

Why is it considered well to bring all BOP's to zero?   If BOP of any country is zero, it reflects that the present account of that country has sufficient balance to meet the n

Non-Accelerating-Inflation Rate of Unemployment (NAIRU): This theory is a variant of neoclassical natural rate of unemployment. As in original natural rate theory, NAIRU advocates

Is the terms of trade (TOT) explained as the ratio of the value of exports to the value of imports? How does the TOT relate to the exchange rate? The terms of trade (TOT) is ex

The Industrial Revolution The century after 1750, saw the industrial revolution proper: invention of steam engine, spinning jenny, power loom, hydraulic press, railroad locomot

During the 1990s, technological advance reduced the cost of computer chips. Explain, with the use supply and demand diagrams, how the following markets are affected in terms of pr

Demand Curve The demand curve is a graph which presents the amount of a good that consumers are willing and able to buy at various prices. A normal demand curve is downward slo

Assume that the U.S. Department of Agriculture (USDA) administers the price floor for cheese, set at $0.17 per pound of cheese. (The price floor is formally set at $16.10 per hundr

What is the difference between houehold and consumers?

. Crumble Corporation produces cookies. Here is the relationship between the number of workers and output (in dozens of cookies) in a given day: Workers Output Marginal Product