<p>Under    rational   expectations    and no  nominal  rigidities,    aggregate   output  is  sensitive    to 
___________ supply  and ___________ demand  shocks.</p>

<p>a) Anticipated, anticipated<br>
(b) Anticipated,    unanticipated<br>
(c) Unanticipated,  anticipated<br>
(d) Unanticipated,  unanticipated</p>

<p>My attempt:
The answer is (d) unanticipated, unanticipated<br>
There is no nominal rigidity, so an expected demand shock would lead to a change in expected prices. Both Aggregate Demand and Supply curves would move so that output remains at full employment. All real variables will remain unchanged.<br>
So only an unanticipated demand shock would cause output to change in the short run.<br>
On the supply side, only unanticipated shocks would cause changes in output, eg. sudden increase in oil prices. </p>

CC BY-SA 4.0
2019-02-25T02:48:54.933Z
Hi: I've been teaching myself this material   and you're correct on unanticipated supply. See Shefrin's text "rational expectations:  for a really nice explanation of this concept. It's the best graphical explanation of this natural rate concept that I've seen.  The demand shock part I'm not sure of because sheffrin considers the example of an increase in money supply which is a supply shock.
mark leeds
CC BY-SA 4.0
2019-02-25T06:40:52.413Z
Hey, thank you so much. I'll look into Shefrin. Isn't a change in money supply a demand shock? It causes the Aggregate Demand curve to shift.
Chetna Ahuja
CC BY-SA 4.0
2019-02-25T18:42:43.107Z
You might be right. I always get confused on this concept. My understanding is that the increase in money supply, increases price level and there is movement along lucas supply curve when price changes. But I could be wrong. Hopefully others more knowledgable will chime in. In fact, if you read Sheffrin, maybe you could explain it. It's Chapter 2 from pages 25-40.
mark leeds
CC BY-SA 4.0
2019-02-25T22:50:50.057Z
just to continue above. the movement along the supply curve doesn't happen  because the expectation of the price increases ( because people associate inflation with higher prices ) so the demand curve shifts due to this vertical change in price expectation of the agents. So, the intersection of the AD and AS occurs at a point of higher price but not greater output. This is all in sheffrin  but I get confused with what the shock actually is when the money supply increases.
mark leeds
CC BY-SA 4.0
2019-02-26T17:41:57.033Z
Chetna: It's also explained quite nicely in 391-402 of the linked paper below. Unfortunately, I'm still not clear on how that translates to the answer to your question. https://www.nber.org/papers/w1224.pdf
mark leeds
CC BY-SA 4.0
2019-02-26T18:31:49.107Z
So I went through Shefrin, and here's what I got: There's two types of shocks, anticipated and unanticipated. If the central bank announces that it will increase money supply, people will expect higher prices in the future. They will alter their expectations and this will affect wage contracts (these are usually indexed for inflation). The price increase causes the AS curve to shift up just as AD shifts up as well. So output remains the same and prices increase. (This concept is better explained Blanchard). This is because people have rational expectations.
Chetna Ahuja
CC BY-SA 4.0
2019-02-26T18:39:36.010Z
The Lucas Supply curve kind of expands on the same concept, that the only time output differs from its full employment level is when there are unexpected shocks i.e. expected price differs from what it turns out to be. My problem is that are prices and wages assumed to be flexible in these models i.e. there is no nominal rigidity? If there is nominal rigidity, do anticipated demand shocks affect output as well?
Chetna Ahuja
CC BY-SA 4.0
2019-02-26T18:54:13.210Z
Mark: thanks for the paper. It cleared up my confusion. It says in the first paragraph on page 407 that with price rigidities, anticipated demand shocks do affect real output under rational expectations. Thanks, again!
Chetna Ahuja
CC BY-SA 4.0
2019-02-26T19:02:31.973Z
Chetna: I'll print out what you said because you know this material better than I so I'll learn something. I'm glad the paper helped. I have two questions: The aggregate supply curve and aggregate demand curves have output on horizontal and prices ( or wage prices or inflation ) on vertical. ( I think ). In general, there are also supply curves for other things besides aggregate output. 1) What is on the two axis for those curves ? Also, how does one know in general if one is talking about demand shock or supply shock ? If I should ask these as seperate threads, I can. Thanks.
mark leeds
CC BY-SA 4.0
2019-02-26T19:08:00.327Z
Chetna: The third to last comment at the link below has pretty much the same questions that I asked here. Thanks for any insights. https://economics.stackexchange.com/questions/26890/is-there-a-definitive-way-to-tell-if-an-action-causes-a-movement-or-shift-in-a-s/26895#26895
mark leeds
CC BY-SA 4.0
2019-02-26T19:18:44.610Z
Chetna: Could you also tell me which Blanchard text you are referrring to.  He's got various co-authors in some and then one by himself. Thanks.
mark leeds
CC BY-SA 4.0
2019-02-27T06:15:59.947Z
Mark: It's true that we have supply and demand curves for other variables (labour, capital, money etc.) We look at the equilibrium in these markets to form the AD/AS curves which are plotted for prices and output. The AS curve is derived from the labour market where wages, employment and price mark-up are decided. The AD curve is derived from equilibrium in the goods and assets markets (money supply/demand comes here). This is the IS-LM model. So any shocks to the goods and asset markets affect the AD curve and any shocks in the labour market affect the AS curve.
Chetna Ahuja
CC BY-SA 4.0
2019-02-27T06:27:21.657Z
I would suggest studying the IS-LM models from Dornbusch and Fischer and then moving onto AD/AS from Blanchard's Macroeconomics. I should point out that these models are kind of outdated and aren't really used anymore (as far as I know) but they help in building a foundation in macroeconomics. Hope this helps!
Chetna Ahuja
CC BY-SA 4.0
2019-02-27T06:46:21.437Z
What is on the axes depends on what market you're looking at. The money market  would be plotted for money(x) and interest rates(y), the labour market is plotted for employment (x) and wages (y) etc.
Chetna Ahuja
CC BY-SA 4.0
2019-02-27T16:28:26.630Z
Chetna:  That was so helpful and really appreciated. I don't know what books are useful-clear and amazon gives varying recommendations so the book suggestions are also really appreciated. All the best.
mark leeds
<macroeconomics>
Rational expectations
Chetna Ahuja
# Rational expectations

(Asked by: username_0 on 2019-02-24)

Under rational expectations and no nominal rigidities, aggregate output is sensitive to
\_\_\_\_\_\_\_\_\_\_\_ supply and \_\_\_\_\_\_\_\_\_\_\_ demand shocks.

a) Anticipated, anticipated  
(b) Anticipated, unanticipated  
(c) Unanticipated, anticipated  
(d) Unanticipated, unanticipated

My attempt:
The answer is (d) unanticipated, unanticipated  
There is no nominal rigidity, so an expected demand shock would lead to a change in expected prices. Both Aggregate Demand and Supply curves would move so that output remains at full employment. All real variables will remain unchanged.  
So only an unanticipated demand shock would cause output to change in the short run.  
On the supply side, only unanticipated shocks would cause changes in output, eg. sudden increase in oil prices.

**Tags:** macroeconomics

> **Comments:**
> **username_1**: Hi: I've been teaching myself this material   and you're correct on unanticipated supply. See Shefrin's text "rational expectations:  for a really nice explanation of this concept. It's the best graphical explanation of this natural rate concept that I've seen.  The demand shock part I'm not sure of because sheffrin considers the example of an increase in money supply which is a supply shock.  
> **username_0**: Hey, thank you so much. I'll look into Shefrin. Isn't a change in money supply a demand shock? It causes the Aggregate Demand curve to shift.  
> **username_1**: You might be right. I always get confused on this concept. My understanding is that the increase in money supply, increases price level and there is movement along lucas supply curve when price changes. But I could be wrong. Hopefully others more knowledgable will chime in. In fact, if you read Sheffrin, maybe you could explain it. It's Chapter 2 from pages 25-40.  
> **username_1**: just to continue above. the movement along the supply curve doesn't happen  because the expectation of the price increases ( because people associate inflation with higher prices ) so the demand curve shifts due to this vertical change in price expectation of the agents. So, the intersection of the AD and AS occurs at a point of higher price but not greater output. This is all in sheffrin  but I get confused with what the shock actually is when the money supply increases.  
> **username_1**: username_0: It's also explained quite nicely in 391-402 of the linked paper below. Unfortunately, I'm still not clear on how that translates to the answer to your question. https://www.nber.org/papers/w1224.pdf  
> **username_0**: So I went through Shefrin, and here's what I got: There's two types of shocks, anticipated and unanticipated. If the central bank announces that it will increase money supply, people will expect higher prices in the future. They will alter their expectations and this will affect wage contracts (these are usually indexed for inflation). The price increase causes the AS curve to shift up just as AD shifts up as well. So output remains the same and prices increase. (This concept is better explained Blanchard). This is because people have rational expectations.  
> **username_0**: The Lucas Supply curve kind of expands on the same concept, that the only time output differs from its full employment level is when there are unexpected shocks i.e. expected price differs from what it turns out to be. My problem is that are prices and wages assumed to be flexible in these models i.e. there is no nominal rigidity? If there is nominal rigidity, do anticipated demand shocks affect output as well?  
> **username_0**: Mark: thanks for the paper. It cleared up my confusion. It says in the first paragraph on page 407 that with price rigidities, anticipated demand shocks do affect real output under rational expectations. Thanks, again!  
> **username_1**: username_0: I'll print out what you said because you know this material better than I so I'll learn something. I'm glad the paper helped. I have two questions: The aggregate supply curve and aggregate demand curves have output on horizontal and prices ( or wage prices or inflation ) on vertical. ( I think ). In general, there are also supply curves for other things besides aggregate output. 1) What is on the two axis for those curves ? Also, how does one know in general if one is talking about demand shock or supply shock ? If I should ask these as seperate threads, I can. Thanks.  
> **username_1**: username_0: The third to last comment at the link below has pretty much the same questions that I asked here. Thanks for any insights. https://economics.stackexchange.com/questions/26890/is-there-a-definitive-way-to-tell-if-an-action-causes-a-movement-or-shift-in-a-s/26895#26895  
> **username_1**: username_0: Could you also tell me which Blanchard text you are referrring to.  He's got various co-authors in some and then one by himself. Thanks.  
> **username_0**: Mark: It's true that we have supply and demand curves for other variables (labour, capital, money etc.) We look at the equilibrium in these markets to form the AD/AS curves which are plotted for prices and output. The AS curve is derived from the labour market where wages, employment and price mark-up are decided. The AD curve is derived from equilibrium in the goods and assets markets (money supply/demand comes here). This is the IS-LM model. So any shocks to the goods and asset markets affect the AD curve and any shocks in the labour market affect the AS curve.  
> **username_0**: I would suggest studying the IS-LM models from Dornbusch and Fischer and then moving onto AD/AS from Blanchard's Macroeconomics. I should point out that these models are kind of outdated and aren't really used anymore (as far as I know) but they help in building a foundation in macroeconomics. Hope this helps!  
> **username_0**: What is on the axes depends on what market you're looking at. The money market  would be plotted for money(x) and interest rates(y), the labour market is plotted for employment (x) and wages (y) etc.  
> **username_1**: username_0:  That was so helpful and really appreciated. I don't know what books are useful-clear and amazon gives varying recommendations so the book suggestions are also really appreciated. All the best.  

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## 0 answers

