Assumptions
In his model, Robert Lucas eliminated the often implicit assumption in most macroeconomic models that people (agents) are easily fooled by government policy-makers. His model does not rely on any asymmetry of information between workers and firms. In microeconomic theory, agents are assumed to be rational i.e. their main aim is Profit maximization. Robert Lucas extended this theory to macroeconomics assuming that people would come to know the model of the economy that policymakers use. This assumption is more commonly known as rational expectations. Rational expectations is the principle that agents in an economic model use the correct conditional expectations, given their information. However, rational expectations does not mean that the agents can foresee the future exactly. If expectations were systematically wrong or biased, agents would learn from their mistakes and change the way they formed expectations. Thus, based on available information, the agents make the most efficient and accurate form of expectations.
The basic idea of the model is that supply (and production) is determined by expected relative prices; when producers expect a high relative price of the good produced on their island, they produce more of it. However, supply decisions are made based on incomplete/imperfect information.
Read more about this topic: Lucas Island Model
Famous quotes containing the word assumptions:
“What a man believes may be ascertained, not from his creed, but from the assumptions on which he habitually acts.”
—George Bernard Shaw (1856–1950)
“Unlike Boswell, whose Journals record a long and unrewarded search for a self, Johnson possessed a formidable one. His life in London—he arrived twenty-five years earlier than Boswell—turned out to be a long defense of the values of Augustan humanism against the pressures of other possibilities. In contrast to Boswell, Johnson possesses an identity not because he has gone in search of one, but because of his allegiance to a set of assumptions that he regards as objectively true.”
—Jeffrey Hart (b. 1930)
“All of the assumptions once made about a parent’s role have been undercut by the specialists. The psychiatric specialists, the psychological specialists, the educational specialists, all have mystified child development. They have fostered the idea that understanding children and promoting their intellectual well-being is too complex for mothers and requires the intervention of experts.”
—Elaine Heffner (20th century)