INTRODUCTION

Expectations are one’s belief that something is going to happen now or something will happen in the future or a particular thing may happen in the future. Everybody or I should say common people think like this about expectations but I am sorry to say that this is not the case with an economist. So let me tell you how an economist proceeds with it.

UNCERTAINTY

The discussions start with a familiar term call uncertainty. The root cause of expectations is only uncertainty. Let us start with an old but simple example. A fair coin is to be tossed and as we know that both head and tail are the equally likely outcomes, so the probability of getting a head is one half and obviously, the probability of getting a tail is also one half. Now if we assign a value zero to the outcome of a head and value unity to the outcome of a tail, we can find the value of an event of tossing coin ten times using expectations. How?

In the above example, we can form expectations about the uncertain value of the given event. Let us first focus on a single event of tossing a coin one time. In this case, both head and tail are equally likely outcomes with value zero and unity respectively. Start with multiplying each outcome value with the associated probabilities of occurrence. The expected value of a single event of tossing a coin will come out to be one half. Since tossing a coin ten times are different or independent experiments, we can get the expected value of an event of tossing ten coins by multiplying one half to ten, which turns out to be five.
Since this value is expected, it can deviate from its mean value, if expectations turn out to be wrong, which could be the case. How?
Suppose in all ten tosses, we get the head every time, then the expected or more certain value of the whole event will be zero.

INDIVIDUAL BEHAVIOUR

Now here comes the most important part in the process of forming expectations, which is individual behavior. We can characterize an individual into three categories here: Risk-Neutral, Risk-Averse and Risk-Lover. Suppose there is a bet on two alternative events (somewhat similar like discussed above) with the same mean value but having a different degree of dispersions or riskiness of deviating from their mean value. If an individual is indifferent between the two bets, he comes under the category of risk-neutral, if he chooses the bet with less risk or less degree of dispersion, he comes under the category of risk-averse and the last one who chooses bet with more risk, comes under the category of risk-lover. This characterization is necessary for forming expectations of an individual as it influences his decisions about an event outcome.

RATIONAL AND ADAPTIVE EXPECTATIONS

How common people unlike economists can form an expectation about an event if they don’t follow this modeling of expectations as discussed above? a big question.
Here comes the role of Rational and Adaptive Expectations. In rational expectations, people formulate their expectations by making the best use of available information in the market about the events. While in adaptive expectations people consider the past trends and past values of the event before forming expectations. They use the information on past forecasting errors to revise and formulate current expectations. In other terms, the current expectations are based on the weighted average of past actual values of the event. The Problem with adaptive expectations is that their adjustment is very sluggish, hence can formulate wrong expectations.
Individuals may not always form a correct expectation but if there expectations turns out to be correct, it is known as Perfect Foresight.

CONCLUSION

This shows that for an economist, expectations mean something more than just call it anticipation or a belief that something is going to happen now or something will happen in the future or a particular thing may happen in the future. They are more interested in constructing the theory of expectations by modeling the manner in which individuals arrive at assessments of their formed expectations using the mathematical expressions as discussed above.