As an economic concept, expectation refers to how individuals and companies view the future of certain economic variables, including market prices, individual income, company profit and taxes. For example, it may be true that the market price of a certain product is now $100.The expectations regarding that market price include how individuals and companies predict that price will change in the near and distant future.
Expectation is an integral concept in economics because individuals’ and companies’ expectations themselves affect the very economic values that the expectations are directed toward. Hence, expectations are a basic part of economic theories. In many of these theories, expectations are assumed to directly affect how an economy develops in the future.
Because both the economy influences expectations and expectations influence the economy, the relationship between the two is delicate; a change in one affects the other. To deal with this problem in economic modeling, economists developed a concept called “rational expectations.” The idea of rational expectations gives consistency and an equilibrium to this problem because it assumes that each individual creates expectations based on both the economy and others’ expectations of the economy.
The notion of expectations assumes individuals and companies must know many details about the economy to make predictions about the future economic state. This notion is not rational, however, since not everyone can know all there is to know about the economy. To accommodate for this fact, economists do not actually assume that the individuals and companies truly do know everything, but instead suppose that these economic players use statistics as a way of learning about the economy. Learning, in economics, allows economists to model the economy in a logical method that accounts for peoples’ knowledge sets changing over time.