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The concept of rational expectations was first introduced by John F. Muth in his paper "Rational Expectations and the Theory of Price Movements" published in 1961. Robert Lucas and Thomas Sargent further developed the theory in the 1970s and 1980s which became seminal works on the topic and were widely used in microeconomics.
For new classicals, countercyclical stimulation of aggregate demand through monetary policy instruments is neither possible nor beneficial if the assumptions of the theory hold. If expectations are rational and if markets are characterized by completely flexible nominal quantities and if shocks are unforeseeable white noises, then macroeconomic ...
New classical economics is based on Walrasian assumptions. All agents are assumed to maximize utility on the basis of rational expectations. At any one time, the economy is assumed to have a unique equilibrium at full employment or potential output achieved through price and wage adjustment. In other words, the market clears at all times.
This does not mean that the rational expectations hypothesis (REH) is not game theory or separate from the cobweb theorem, but vice versa. The "there must be" a random component claim by Alan A. Walters alone shows that rational (consistent) expectations is game theory, [5] since the component is there to create an illusion of random walk.
Two main assumptions define the New Keynesian approach to macroeconomics. Like the New Classical approach, New Keynesian macroeconomic analysis usually assumes that households and firms have rational expectations. However, the two schools differ in that New Keynesian analysis usually assumes a variety of market failures.
Robert Hall was the first to derive the effects of rational expectations for consumption. His theory states that if Milton Friedman’s permanent income hypothesis is correct, which in short says current income should be viewed as the sum of permanent income and transitory income and that consumption depends primarily on permanent income, and if consumers have rational expectations, then any ...
Rational choice theory, a cornerstone of microeconomics, builds this postulate to model aggregate social behaviour. The expected utility hypothesis states an agent chooses between risky prospects by comparing expected utility values (i.e., the weighted sum of adding the respective utility values of payoffs multiplied by their probabilities).
Lucas (1972) incorporated the idea of rational expectations into a dynamic macroeconomic models. The agents in Lucas's model are rational: based on the available information, they form expectations about future prices and quantities, and based on these expectations they act to maximize their expected lifetime utility. [ 18 ]