What is the difference between adaptive expectations and rational expectations?

What is the difference between adaptive expectations and rational expectations Introduction: Expectations in Economic Theory Greetings, fellow learners! Before we delve into the specifics, let's establish the importance of expectations in the realm of economic theory. Expectations, in this context, refer to the beliefs or predictions individuals hold regarding future economic variables, such as inflation rates, interest rates, or even stock market performance. These expectations, in turn, influence their decision-making processes, be it in terms of consumption, investment, or saving. Hence, understanding how expectations are formed becomes crucial in comprehending economic dynamics. Adaptive Expectations: The Historical Approach Adaptive expectations, as the name suggests, are expectations that adapt or change based on past experiences. This approach assumes that individuals form their expectations by considering the recent history of a variable. For instance, if inflation has been high in the past, individuals might expect it to remain high in the future. This approach is rooted in the idea that people tend to rely on historical patterns and are slow to update their expectations. As a result, adaptive expectations can lead to persistent trends and even self-fulfilling prophecies in the economy. Rational Expectations: The Forward-Looking Paradigm