Adaptive Expectations theory is based on which premise?

Adaptive Expectations theory posits that individuals form their expectations about the future based on past experiences and recent trends. This approach suggests that changes in economic circumstances will influence people's expectations in a gradual manner as new information becomes available. Specifically, individuals adjust their expectations based on the most recent data, which means that their predictions about economic variables, such as inflation or interest rates, are influenced heavily by what has occurred recently.

For example, if inflation has been rising over the past few months, individuals might expect that this trend will continue, thereby adjusting their expectations accordingly. This method of forming expectations reflects a pragmatic approach to decision-making in an uncertain economic environment, rather than relying solely on historical averages or static factors.

In contrast to the other options, the premise of Adaptive Expectations emphasizes the importance of recent trends rather than solely relying on historical averages or claiming that all economic decisions are inherently rational. This understanding of how individuals interact with economic data is vital for grasping various economic behaviors and outcomes.