Question

If most people have rational expectations, how long will recessions last?

a) Short-term, as individuals quickly adjust to changing economic conditions.
b) Long-term, due to persistent market uncertainties.
c) Indefinitely, as rational expectations lead to stagnation.
d) Variable, depending on government intervention effectiveness.

Answer 1

In the context of rational expectations, recessions would be short-lived as individuals quickly adjust behaviors. However, the presence of adaptive expectations leads to a more gradual response, making recession lengths variable.

Step-by-step explanation:

The question you're asking is related to how the theory of rational expectations influences the duration of recessions. This theory assumes that individuals and businesses make forecasts about the future using all available information, thereby adjusting quickly to economic shifts. However, this is an idealized framework; in reality, many market participants operate with adaptive expectations, adjusting to changes in the economy based on past experiences in a more gradual process. The theory of rational expectations suggests that if everyone predicts economic changes accurately, recessions would be short-lived as people would quickly respond by adapting their behavior. Nevertheless, due to imperfect information and the gradual adaptation of expectations, the duration of recessions is more likely to be variable.