Final answer:
In the short-run aggregate model, firms may be unable to immediately adjust wages and prices, causing them to respond to current demand conditions. Rational expectations suggest firms will anticipate long-term price level changes rather than undergoing short-term labor adjustments. Therefore, expected long-run changes in price levels can occur rapidly in this context.
Step-by-step explanation:
The short-run assumptions of our aggregate model include firms unable to adjust wages and prices quickly, and planned aggregate expenditure is determined by the current economic conditions such as interest rates, confidence, and wealth levels. In the short run, firms might stick to their plans and produce based on expected sales, which could be influenced by current demand conditions. The short-run aggregate supply curve implies that firms may respond to changes in aggregate demand by altering production to support equilibrium. However, if they have rational expectations, they will anticipate changes in price levels rather than allow a prolonged mismatch of output and employment.
The concepts of aggregate supply (AS) and aggregate demand (AD) are crucial here, with AS representing the total quantity of goods and services firms are willing to produce at a given overall price level. The theory of rational expectations suggests that any impact on output and employment in response to a shift in AD is temporary, while the impact on price levels is permanent.
When the economy experiences a shift in aggregate demand, individuals and firms with rational expectations understand that this will lead to eventual changes in the price level, and they may adjust their behaviors immediately rather than going through a series of short-run adjustments. As a result, in the context of rational expectations, the expected long-run change in the price level may occur rapidly, without the intermediary steps of varying output and employment levels.