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And finance Allah shmoop what are rational expectations Alright people

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Well life can change pretty quickly One day you're the

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CEO of a Wall Street hedge fund making a fifteen

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twenty thirty million dollars a year or more than one

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bad experience with a cursive monkey paw and poof You're

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the break dance guy on the subway busking for ninety

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bucks a day in tips Yeah I guess you shouldn't

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have wished to become a better dancer Well but given

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that you can never tell exactly what will happen in

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the future how do you decide what to do Day

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today Lt'll economists have a model they use It's called

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rational expectations The theory assumes that people make economic decisions

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based on their reasonable assumptions about what's gonna happen in

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the future Folks look at their current situation and it

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what's happened in the past and from there they make

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educated guesses about what's likely to happen in the future

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Well these expectations in turn become the bases or foundation

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for their decision making Gas prices have been low forest

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long as you can remember so you don't care much

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about fuel efficiency when you go out and buy a

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car So you go for the ten miles a gallon

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Hummer Rational expectation Until militants take over Saudi Arabia's largest

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oil production field gas prices spike Now you're paying two

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hundred dollars a month to fill your gas tank Remember

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a lot of economic activity is based on what people

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think will happen in the future Will people borrow money

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planning to pay it back years In the future they

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buy houses with thirty year mortgages They choose college majors

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with an eye toward a forty year career Well aside

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from philosophy majors maybe people make decisions based on what

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they think the future will be like right Robert Lucas

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won the Nobel Prize in nineteen ninety five for his

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work on the theory of rational expectations This guy well

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quick fun fact When Lucas Scott divorce from his wife

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Rita in the late nineteen eighties the divorce agreement included

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a stipulation that she would get half of his Nobel

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Prize winnings if he ever won the award However the

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Klaus had an expiration date of Halloween nineteen ninety five

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He officially won his prize on October tenth nineteen ninety

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five just under the wire So okay most of us

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don't rationally expect our spouse is to win half a

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Nobel Prize kind of money but most of us are

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just happy if they remember to put down the toilet

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seat But yeah we do make other long term decisions

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based on what we think we'll be able to make

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on an ongoing basis in your hedge fund days You

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wouldn't think twice about taking on a five million dollar

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mortgage for a vacation place in Bermuda However you never

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take on that responsibility If you knew that your monkey

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paw wish was going to go sideways and you know

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leave you with eighteen thousand dollars in annual salary your

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rational expectations impact your big long term money making decisions

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They also play into your smaller data day decisions Even

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deciding what you're going to have for dinner relates to

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how much money you expect to make in the near

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future Will the precursor version of you while you then

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might have gotten the nine course tasting menu It hearsay

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with the caviar Black Australian truffles flog raw and wagyu

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beef The bill would run six hundred bucks a person

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but you can afford it So like who cares The

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post curse break dance version of you might decide to

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go with the Junior Bacon cheeseburger off Lindy's Value menu

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which costs a buck ninety nine Yeah that's all you

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can afford But the rational part of rational expectations assumes

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that your predictions will stem from past experience Unless you've

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had trouble with cursing objects before it's unlikely that you'll

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see the bad wish scenario coming Given that you've been

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a fifteen million dollars plus a year hedge fund manager

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for twenty years at five million dollars vacation home or

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good seems very manageable There's no reason to expect your

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job to change The reasonable assumption is that you'll keep

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your fat salary for the foreseeable future Well dinner's at

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per se a vacation spots in Bermuda Yeah but then

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you wandered into that dingy curiosity shop on your last

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trip to Hong Kong and asked the man behind the

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counter if he had anything really interesting Then he started

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stroking his beard and well on the bright side you

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always wanted to be able to do the worm Yeah 00:03:55.178 --> [endTime] Yeah

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