If people act with rational expectations, how are they likely to respond to changes in incentives?

• A. They will ignore the incentives and continue with their previous behavior.
• B. They will always respond in a way that decreases their utility.
• C. They will respond randomly, without considering the incentives.
• D. They will adjust their behavior to maximize their utility based on the new incentives.

Answer: (D)

Verified step by step guidance

1. Understand the concept of rational expectations: it means that individuals use all available information, including knowledge about economic policies and incentives, to make decisions that maximize their utility.
2. Recognize that when incentives change, rational agents anticipate these changes and adjust their behavior accordingly rather than ignoring the new information.
3. Analyze how individuals evaluate the new incentives by comparing the expected benefits and costs associated with different choices.
4. Conclude that rational agents will choose the option that maximizes their expected utility given the new incentives, rather than acting randomly or in a way that reduces their utility.
5. Therefore, the correct response to changes in incentives under rational expectations is that people adjust their behavior to maximize their utility based on the new incentives.