Rational Expectations Theory

AAA

DEFINITION of 'Rational Expectations Theory'

An economic idea that the people in the economy make choices based on their rational outlook, available information and past experiences. The theory suggests that the current expectations in the economy are equivalent to what the future state of the economy will be. This contrasts the idea that government policy influences the decisions of people in the economy.

INVESTOPEDIA EXPLAINS 'Rational Expectations Theory'

The idea is that rational expectations of the players in an economy will partially affect what happens to the economy in the future. If a company believes that the price for its product will be higher in the future, it will stop or slow production until the price rises. Because the company weakens supply while demand stays the same, price will increase. In sum, the producer believes that the price will rise in the future, makes a rational decision to slow production and this decision partially affects what happens in the future.

RELATED TERMS
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects ...
  2. Sunspot

    In economics, sunspots are extrinsic random variables upon which ...
  3. Beginning Market Value (BMV)

    The valuation at which the property should exchange at the date ...
  4. Laissez Faire

    An economic theory from the 18th century that is strongly opposed ...
  5. Inflationary Psychology

    A state of mind that leads consumers to spend more quickly in ...
  6. Economy

    The large set of inter-related economic production and consumption ...
RELATED FAQS
  1. Which factors have the most influence on the law of demand?

    According to economic theory, the law of demand states that the relative demand for a good or service is inversely correlated ... Read Full Answer >>
  2. Why do economists think it is important to track discretionary income?

    Economists track discretionary, and disposable, income as a proxy for the growth in the financial health of average citizens ... Read Full Answer >>
  3. What is the relationship between research and development and innovation?

    Although it's possible to achieve innovation without research and development and it's possible to conduct research and development ... Read Full Answer >>
  4. How is minimum transfer price calculated?

    A company that transfers goods between multiple divisions needs to establish a transfer price so that each division can track ... Read Full Answer >>
  5. How does neoclassical economics relate to neoliberalism?

    While it may be likely that many neoliberal thinkers endorse the use of (or even emphasize) neoclassical economics, the two ... Read Full Answer >>
  6. What are common concepts and techniques of managerial accounting?

    The common concepts and techniques of managerial accounting are all the concepts and techniques that surround planning and ... Read Full Answer >>
Related Articles
  1. Economics

    Economics Basics

    Learn economics principles such as the relationship of supply and demand, elasticity, utility, and more!
  2. Active Trading Fundamentals

    Understanding Investor Behavior

    Discover how some strange human tendencies can play out in the market, posing the question: are we really rational?
  3. Personal Finance

    5 Economic Concepts Consumers Need To Know

    A solid understanding of economics helps build a strong foundation in almost every area of life.
  4. Options & Futures

    Explaining The World Through Macroeconomic Analysis

    From unemployment and inflation to government policy, learn what macroeconomics measures and how it affects everyone.
  5. Personal Finance

    Microeconomics

    This tutorial teaches the basics of one of the most important economic topics. A must for all investors.
  6. Economics

    Calculating Income Elasticity of Demand

    Income elasticity of demand is a measure of how consumer demand changes when income changes.
  7. Economics

    Understanding Implicit Costs

    An implicit cost is any cost associated with not taking a certain action.
  8. Economics

    Understanding Diseconomies of Scale

    Diseconomies of scale is the point where a business no longer experiences decreasing costs per unit of output.
  9. Economics

    What Does Capital Intensive Mean?

    Capital intensive refers to a business or industry that requires a substantial amount of money or financial resources to engage in its specific business.
  10. Economics

    What is an Original Equipment Manufacturer (OEM)?

    An OEM is a company whose products are used as components in another company's product.

You May Also Like

Hot Definitions
  1. ZEW Economic Sentiment

    A monthly economic survey. The ZEW Economic Sentiment is an almalgamation of the sentiments of approximately 350 economists ...
  2. Radner Equilibrium

    A theory suggesting that if economic decision makers have unlimited computational capacity for choice among strategies, then ...
  3. Inbound Cash Flow

    Any currency that a company or individual receives through conducting a transaction with another party. Inbound cash flow ...
  4. Social Security

    A United States federal program of social insurance and benefits developed in 1935. The Social Security program's benefits ...
  5. American Dream

    The belief that anyone, regardless of where they were born or what class they were born into, can attain their own version ...
  6. Multicurrency Note Facility

    A credit facility that finances short- to medium-term Euro notes. Multicurrency note facilities are denominated in many currencies. ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!