Monetarism and Economic Theory by Essay

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The competitive equilibrium

The competitive general equilibrium tries to give an understanding of the whole economy using a "bottom-up" approach, starting with individual markets and agents, as a microeconomic approach. The rational expectations theory is based off this microeconomic approach, where it assumes that each individual agent is capable of quickly adapting to market changes and solving for the competitive equilibrium. This bottom-up approach and the concept of quick adaptation have been the source of much criticism about the rational expectations theory.

II. Flaws

Application of rational expectation to aggregate behavior

The main idea behind the rational expectations hypothesis is to consistently extend the principle of individual rationality from the problem of the allocation of resources.

The problem is the hypothesis's application to aggregate behavior. Even if all individual agents have rational expectations, the representative corporation/household/industry describing these behavior may not collectively make efficient use of all given information. Hence, in the aggregate, agents may not satisfy rational assumptions, and hence does not have macroeconomic applicability.

The rational expectation accounts only for rationing by price

The rational expectation theory is inapplicable with the law of diminishing occurrence.

Expectations of sales and prices will determine an employer's willingness to hire employees.

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When demand is low, if an employer is at labor capacity, a lower wage will not lower unemployment rates unless it is sufficiently low to benefit the employer enough to hire an unemployed laborer at the lower rate in the place of an already trained current employee. The monetaristic view takes into account only price, so rational expectation is that if the wages drop unemployment will be benefited, and further if wages drop then price and drop and demand will increase. It does not take into account, hiring freezes, training costs and expertise of current employees.

Rational expectation standard as it relates to fiscal policy

Rational expectation assumes that macro-policy will be of limited use to society because of the hypothesis's primary assumption that agents adapt quickly. The idea is that they will adapt to changes in policy, and will obtain all relevant information to efficiently adjust forecasts in benefit of earning money

. However, more modern models have indicated the positive effects of fiscal policy.

F.H. Hahn, Monetarism and Economic Theory, Economica, New Series, Vol. 47, No. 185. (Feb., 1980), 6.

Hahn, 2.

Hahn, 2.

Hahn, 6.….....

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