Question

The rational expectation theory. What is the theory? Provide an example of this theory, use your knowledge of economics, explain if you agree or disagree with this theory and why

Answer 1

The rational expectations theory is an economic concept whereby people make choices based on their rational outlook, available information and past experiences. The theory suggests that the current expectations in an economy are equivalent to what people think the future state of the economy will become. This contrasts with the idea that government policy influences people's decisions.

The rational expectations theory also explains how producers and suppliers use past events to predict future business operations. If a company believes that the price for its product will be higher in the future, for example, it will stop or slow production until the price rises. Since the company weakens supply while demand stays the same, the price will increase. The producer believes that the price will rise in the future and makes a rational decision to slow production, and this decision partially affects what happens in the future. By relying on the rational expectations theory, companies can inadvertently effect future inflation in an economy.

I personally agree with rational expectation theory. It is human tendency to always judge the events by looking at the past. consider for example if during last inflation the stock price of some company fell by some value. If the rate of inflation is same today then its natural for me to think that the stock price will fall again so this is rational expectation