Despite being said about the explainatory validity of rational expectation in addressing peoples’ formation of expectation based on available market information, it is too costly in gathering this typical information which is supposedly not readily available to the ordinary people. Even though the so-called optimal forecast (best guess of the future) is the best that closely represents the actual situation, it might be even too expensive to achieve in its entirety. The rationale is that the future cannot be predicted, so that no expectations can be truly “rational”.
Owing to the fact that people are neither perfectly rational nor perfectly informed, it is unreasonable to believe that business owners generally fix their prices with reference to the macroeconomic trends. It might be difficult to get hold of current information on the Federal Reserve's rates and policies as well as the inflation and unemployment rates or even the nation's GDP growth. Even more improbably, how would the people set their budget, prices and wage demands by these indicators accordingly and accurately? This leads the market to have reacted in disequilibrium as opposed to the suggested one and only market equilibrium in rational expectation; as empirical evidence shows that income does not rise in tandem with the escalating cost of living lately.
Lastly, the application of rational expectation hypothesis fails to account for human behaviour in its totality. It simply means that individuals might not draw behavioral references from the prescribed norm that is representative of the group behaviour. People have mixed views and are just biased right through their skins!!! “…..Even if all individuals have rational expectations, the representative individual describing these behaviours may exhibit behaviour that does not satisfy rational expectations (Jansen 1993). In other words, they might have reacted differently given the same set information available in the market place.
Extrapolations have been made from these perceived weaknesses of the rational expectation model, will be discussed in full details later…..
Owing to the fact that people are neither perfectly rational nor perfectly informed, it is unreasonable to believe that business owners generally fix their prices with reference to the macroeconomic trends. It might be difficult to get hold of current information on the Federal Reserve's rates and policies as well as the inflation and unemployment rates or even the nation's GDP growth. Even more improbably, how would the people set their budget, prices and wage demands by these indicators accordingly and accurately? This leads the market to have reacted in disequilibrium as opposed to the suggested one and only market equilibrium in rational expectation; as empirical evidence shows that income does not rise in tandem with the escalating cost of living lately.
Lastly, the application of rational expectation hypothesis fails to account for human behaviour in its totality. It simply means that individuals might not draw behavioral references from the prescribed norm that is representative of the group behaviour. People have mixed views and are just biased right through their skins!!! “…..Even if all individuals have rational expectations, the representative individual describing these behaviours may exhibit behaviour that does not satisfy rational expectations (Jansen 1993). In other words, they might have reacted differently given the same set information available in the market place.
Extrapolations have been made from these perceived weaknesses of the rational expectation model, will be discussed in full details later…..
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2 comments:
I did get what you are trying to say here even though I had to read a couple of times. ;-)
Welcome to the Blogosphere. One thing though - I wish the font was a bit bigger. It's quite hard to read at the present size and with the choice of background colour.
I have amended accordingly. Thanks.
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