Non-systematic errors. The disadvantage of other ways in which individuals may be assumed to

Predict the future is that they allow them to make systematic errors. Adaptive expectations, for example,

postulate that individuals predict next year’s price inflation on the basis of last year’s, and the rate of

17.7.1.3. Read and translate the text “Comparative Static Equilibrium Analysis.”

Comparative Static Equilibrium Analysis

Forecast o f Rational Expectations Theory

Change up to last year. At a time of increasing inflation, their expectation will perpetually lag behind the

Actual inflation rate — but despite this, under the hypothesis of adaptive expectations, everybody carries

On using this predictive method although it produces biased forecasts.

The theory of rational expectations has stimulated debate in economics because it has controversial

Implications. The first is that it appears to demolish any case for government policy aimed at stimulating

demand in the economy: if the government expands the money supply by 5 per cent, everybody will

Believe that prices will rise as a consequence. This will make them add 5 per cent to their wage demands

Or prices and a 5 per cent price inflation occurs without there being any positive effect on output or

Employment. The second is that markets behave efficiently. The price of the shares of a company reflects