Perfect Foresight
You step into Madame Sybil's House of Augurs and ask her about your future. She looks into her crystal ball. Suddenly, she's in a trance. She sees...she sees...long hours sitting around in pajama pants, eating the crumbs from the bottom of a Doritos bags and watching the Love Actually director's cut on a constant loop.
At first, you're skeptical. Leaving her parlor, you scoff. You figure it's all a scam. Then comes the weekend. At some point, as you brush Dorito detritus from your pajama pants and tear up at the extended version of the doorway cue-card scene, you realize...it all came true.
Madame Sybil saw the future!
That's perfect foresight. The complete, accurate knowledge of what's going to happen. Obviously, it’s not something many people have. Madame Sybil might have the gift. Or maybe (probably) she just took one look at you and made an educated guess. Generally speaking, however, perfect foresight...doesn't exist. Need evidence? Just go to a race track. Or the stock market.
But the idea of perfect foresight plays a role in some economic discussions. Economics, in real life, is complicated. To look at the total economy of a big country, like the United States, you're really looking at the day-to-day individual decisions of hundreds of millions of people. We're talking billions of small transactions, each one a complicated tangle of motivations and incentives.
Modeling that kind of thing with 100% accuracy is impossible. So to make any type of predictions about the future, economists have to make assumptions. They just have to...simplify. (Hello, Thoreau.)
Enter perfect foresight. It describes the ideal situation for an economic actor. A person with perfect foresight knows exactly what will happen when they make an economic decision: buy a car, invest in a stock, purchase the softest, most durable pajama pants they can find. Because they have perfect foresight, they will always do the thing that benefits them the most.
Making this assumption allows economists to at least determine how certain scenarios should unfold. It allows them to model economic behavior. Think of how a physicist can predict what will happen if you drop a penny off a tall building. They can take into account the distance it's falling, the gravitational constants, and stuff like air resistance. From that, they can tell you with certainty whether the penny is going to kill someone on the street if it hits them in the head.
That physicist has perfect foresight of the movement of that penny. Unfortunately, econ doesn't play out like physics. Economics deals with the decisions of people. And people are...weird.
So, as a result, econ involves all sorts of uncertainties and psychology and other quirks that make it much harder to model than a penny falling from the sky. In practice, perfect insight doesn't come into play. For most economic models, a slightly less strict assumption is made: rational expectations.
Instead of assuming people have perfect knowledge of the future, the theory of rational expectations proposes that people act on their most reasonable guesses about the future. The expectations are based on things like the current situation and their experience about what's happened in the past.
Apply this model to your trip to Madame Sybil. She didn't need perfect insight. A rational expectation about your weekend leads to the same conclusion.
Madame Sybil can take one look at you and reasonably predict that Doritos and couch potato time are in your future. Doesn't exactly take a Nostradamus to put two and two together.
Related or Semi-related Video
Econ: What is Perfect Foresight?4 Views
And finance Allah Shmoop what is perfect foresight Will you
step into Madame Symbols House of augers and you ask
her about your future She looks into her crystal ball
Suddenly she's in a trance She sees she sees long
hours sitting around in pajama pants eating the crumbs from
the bottom of a Doritos bag and watching the love
Actually director's cut on a continual loop goes four hours
All right At first you're skeptical leaving her parlor You
scoff You figure it's all a scam Then comes the
weekend Well at some point as you brushed Dorito treatise
from Europe pajama pants there and tear up the extended
version of the doorway Cue card senior Remember that you
realized it all came true Madam Sibyl saw the future
That's perfect foresight The complete accurate knowledge of what's gonna
happen Well obviously it's not something many people have Madame
Civil might have the gift Or maybe she just took
one look at you and kind of made a good
educated guess But generally speaking perfect foresight does not exist
Need evidence Well just go to a racetrack or the
stock market But the idea of perfect foresight plays a
role in some economic discussions Will economics in real life
is complicated to look at the total economy of a
big country like the United States You're really looking at
the day today individual decisions of hundreds of millions of
people were talking billions of small transactions happening all the
time Each one a complicated tangle of motivations and incentives
will modeling that kind of thing financially with one hundred
percent accuracy is impossible So to make any type of
prediction about the future economists have to make assumptions Will
economists generally have to start by simplifying Okay answer perfect
foresight It describes the ideal situation for an economic act
or a person with perfect foresight knows exactly what will
happen when they make an economic decision like buy a
car or invest in the stock or purchase the softest
most durable pajama pants They confined well because they have
perfect foresight They will always do the thing that benefits
them the most Making this assumption allows economist to at
least determine how certain scenarios should unfold It allows them
to model economic behavior Think of how a physicist can
predict what will happen if you dropped a pea Kenny
off a tall building they can take into account the
distance it's falling the gravitational constant of things like air
resistance and so on And from that well they can
tell you with certainty whether the penny is going to
kill someone on the street if it hits them square
on the head Well that physicist has perfect foresight of
the movement of that penny Thank you physics Unfortunately E
con doesn't play out like physics Economics deals with the
decisions of people and people are Yes we're just saying
weird So as a result E Con involves all sorts
of uncertainties and psychology and other quirks that make it
much harder to model in the any falling from the
sky Well in practice perfect insight doesn't come into play
For most economic models a slightly less strict assumption is
made We're going to assume rational expectations like instead of
assuming people have perfect knowledge of the future The theory
of rational expectations proposes that people act on their most
reasonable guesses about the future The expectations are based on
things like while the current situation and their experience about
what's happened in the past then apply this model to
your trip to Madame Sibyl She didn't need perfect insight
A rational expectation about your weekend leads to the same
conclusion Yeah Madame Sibyl can take one look at you
and reasonably predict that Doritos and couch potato time Our
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