Adaptive Expectations Hypothesis - Explained
What is Adaptive Expectations Hypothesis?
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What is the Adaptive Expectations Hypothesis?
Adaptive Expectations Hypothesis theory states that people adjust their expectations on what the future will be based on experiences and events of the recent past.
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Adaptive expectation is closely related to rational expectations.
In rational expectations, an individual bases his or her expectations on three factors: available information, past experience, and human reasoning.
The main difference between adaptive expectations and rational expectation is that adaptive expectation uses real time data while rational expectation uses historical data.
Adaptive Expectation Formula
A simple formula for applying adaptive expectation theory to expected inflation in an economy is:
pe = pe-1+ (p-pe-1)
pe is next years inflation rate that is expected currently
pe-1 is this years inflation rate that was expected the previous year
p is this years actual rate of inflation is between 0 and 1
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