Rational Expectations Hypothesis


The idea that individuals form expectations based on all available past and current information.

A basic example of rational expectations theory is a situation in which a consumer delays buying a certain good because, based on his/her observations and experiences, he/she believes that the price will lower in a month. If enough consumers believe that, demand eases and the good is likely to actually be less expensive next month. Thus, the consumer waits a month before buying the good. Rational expectations theory states that current expectations strongly influence future performance. Economists disagree about how well the rational expectations theory works in the real world.
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