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The economic hypothesis of “rational expectations” suggests that outcomes depend on people’s expectations, which are influenced by past situations and available information. It considers the general public an important economic actor and assumes people act to maximize profits. It contrasts with the concept of “adaptive expectations,” which suggests people gradually adapt after a given situation. Rational expectations believe that a given economic outcome does not differ significantly from what people expect to happen.
“Rational expectations” is the name of a hypothesis in economics that states that an outcome depends largely on what people expect to happen in the future. People’s expectations are fueled by past economic situations and available and relevant information. This economic hypothesis also considers the general public to be an important economic actor, rather than just the government and its policies as the main actors in changing economic outcomes.
John Muth conceptualized the notion of rational expectations in 1961 when he wrote a paper entitled “Rational Expectations and the Theory of Price Movements”. The economic hypothesis was Muth’s counter-response to a contemporary concept called adaptive expectations. The common ground for both theories is that people adapt to change and learn from experience, but adaptive expectations state that people gradually adapt after a given situation, in contrast to the idea of rational expectations that people have. the ability to learn quickly and adapt simultaneously to the economy. situations as they are occurring. Later, Muth’s hypothesis came to the fore after other economists such as Robert Lucas Jr., Edward Prescott, and Neil Wallace made use of it.
In rational expectations, the two elements, result and expectation, feed and affect each other. What people expect to happen will be the driving force behind their future actions, which in turn will shape the outcome. The present result, on the other hand, will create a new expectation and the cycle will continue. In exchange rates, for example, if people expect a certain currency to depreciate, it will lead them to give up their investments, which will cause the currency to decrease in value.
On a larger scale, one individual’s expectation can also influence the expectation of another, triggering a collective expectation of a situation. This increases the likelihood that an expectation will be realized. In this way, rational expectations believe that a given economic outcome does not differ significantly from what people expect to happen, making the theory an expectation consistent with the model. This belief is applied to applied mathematics, particularly game theory, which holds that a person relies on anticipating other people’s choices to succeed in any situation that requires strategy.
Building on the term itself, rational expectation also assumes that people act in ways that get the most out of their resources and profits. Another theory is called rational choice theory. It applies this assumption by stating that people typically make choices to increase their profits and reduce costs.
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