adaptive expectations theory

Examples of adaptive expectations theory in the following topics:

• Relationship Between Expectations and Inflation

  • There are two theories of expectations (adaptive or rational) that predict how people will react to inflation.
  • The theory of adaptive expectations states that individuals will form future expectations based on past events.
  • Accordingly, because of the adaptive expectations theory, workers will expect the 2% inflation rate to continue, so they will incorporate this expected increase into future labor bargaining agreements.
  • This example highlights how the theory of adaptive expectations predicts that there are no long-run trade-offs between unemployment and inflation.
  • According to adaptive expectations theory, policies designed to lower unemployment will move the economy from point A through point B, a transition period when unemployment is temporarily lowered at the cost of higher inflation.

• Keynesian Theory

  • In economics, the Keynesian theory was first introduced by British economist John Maynard Keynes in his book The General Theory of Employment, Interest, and Money which was published in 1936 during the Great Depression .
  • According to the Keynesian theory, aggregate demand does not necessarily equal the productive capacity of the economy.
  • Although the beliefs of each school vary, all of the schools of economic thought have contributed to economic theory is some way.
  • In contrast, the Chicago School of economic thought focused price theory, rational expectations, and free market policies with little government intervention.
  • John Maynard Keynes introduced Keynesian theory in his book, The General Theory of Employment, Interest, and Money.

• Theory of Utility

  • The theory of utility states that, all else equal, a rational person will always choose the option that has the highest utility.
  • The theory of utility is based on the assumption of that individuals are rational.
  • If, when everything is taken into account, one decision provides the greatest utility, which is equivalent to meaning that it is the most preferred, then we would expect the individual to take that most preferred option.

• Microeconomics

  • A sense of community where expectations and social sanctions may enforce the reciprocal obligations may substitute for trust.
  • Philanthropy is giving gifts with nothing expected in return.
  • Theory is an explanation about the way the world works.
  • Orthodox microeconomic theory can be thought of as a set of "tools," as a perspective or as a way of thinking.
  • As a set of tools, economic theory can be envisioned as a road map.

• The Long-Run Phillips Curve

  • The natural rate of unemployment theory, also known as the non-accelerating inflation rate of unemployment (NAIRU) theory, was developed by economists Milton Friedman and Edmund Phelps.
  • The reason the short-run Phillips curve shifts is due to the changes in inflation expectations.
  • As such, in the future, they will renegotiate their nominal wages to reflect the higher expected inflation rate, in order to keep their real wages the same.
  • The NAIRU theory was used to explain the stagflation phenomenon of the 1970's, when the classic Phillips curve could not.
  • According to the theory, the simultaneously high rates of unemployment and inflation could be explained because workers changed their inflation expectations, shifting the short-run Phillips curve, and increasing the prevailing rate of inflation in the economy.

• The Magic of the Economy

  • The evaluation of human interactions as it relates to preferences, decision making, and constraints is a significant foundation of economic theory.
  • The complexity of the dynamics of human motivation and systems has led to the establishment of assumptions that form the basis of the theory of consumer and firm behavior, both of which are used to model circular flow interactions within the economy .
  • Economics also allows individual agents to balance expectations.
  • Since economic theories are a basis of decision making and regulatory policy, being knowledgable about economics foundations allows an individual to be an active and aware participant rather than a passive economic agent.

• Introduction to Inflation

  • Built-in inflation is the result of adaptive expectations.
  • If workers expect there to be inflation, they will negotiate for wages increasing at or above the rate of inflation (so as to avoid losing purchasing power).
  • Thus, there is a cycle of expectations and inflation driving one another.

• Keynesian Theory

  • Keynesian theory posits that aggregate demand will not always meet the supply produced.
  • John Maynard Keynes published a book in 1936 called The General Theory of Employment, Interest, and Money, laying the groundwork for his legacy of the Keynesian Theory of Economics.
  • With this overview in mind, Keynesian Theory generally observes the following concepts:
  • Fiscal Policy:The key concept in fiscal policy for Keynes is 'counter-cyclical' fiscal policy, which is the expectation that governments can reduce the negative effects of the natural business cycle.
  • John Maynard Keynes came to fame after publishing his economic theories during the Great Depression.

• Cost of capital

  • Firms usually calculate a single cost of capital number, and, under economic theory, will only pursue projects with an expected return greater than the cost of capital.
  • It determines the minimum return that investors expect for providing capital to the company.
  • In order for an investment to be worthwhile, the expected return on capital has to be higher than the cost of capital.

• Alternative Views

  • The history of different economic schools of thought have consistently generated evolving theories of economics as new data and new perspectives are taken into consideration.
  • The two most well-known schools, classical economics and Keynesian economics, have been adapting to incorporate new information and ideas from one another as well as lesser known schools of economics (Chicago, Austrian, etc.).
  • The basic idea is that aggregate demand will adjust to supply, and that value theory and distribution will reflect this rational, cost of production model.
  • When learning about these economic perspectives, it is important to understand the value they add to one another and the overall efficacy of all economic theory.