Question

INSTRUCTIONS: DEFINE THE FOLLOWING TERMS AND CONCEPTS IN A CLEAR, CONCISE, AND EXPLICIT WAY. DEMONSTRATE THE RELATIONS BETWEEN THEM!

• Animal spirits & rational expectations;

Answer 1

Animal Spirit:

• Unlike rational decision, animal spirit refers to the emotion, pessimism and confidence. If animal spirit is high, then it will drive market up. Furthermore, if animal spirit is low, it will drive market down. Animal spirit can harm economic growth even if economy has strong and sustained fundamentals.

Rational expectation:

• According to rational expectation theory, an individual takes economic decision based on available information and past experiences. It results into change in economic behavior of an individual. Rational expectations may render fiscal and monetary policy useless, since economic agents would prejudge economic results of economic policies and would act and react accordingly.

Relationship between Animal Spirit and Rational Expectations:

• Animal spirit is guided through the confidence and emotions. Economic agents do not take rational and prudent decisions. Hence, even strong and positive fundamental of economy may also fail to stimulate economic activities. Consumers and economic agents begin to behaving irrationally. Hence, in animal spirit, rational economic agent becomes irrational and behave irrationally.