Differentiate between adaptive expectations and rational expectations. Explain why the shape of the Phillips curve changes when we introduce expectations in our analysis

Adaptive expectations assume that individuals form their future expectations based on past experiences, adjusting predictions gradually over time.

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In contrast, rational expectations posit that individuals use all available information, including past and current data, to form expectations that are as accurate as possible.

When expectations are introduced into the analysis of the Phillips curve, which depicts the inverse relationship between inflation and unemployment, the shape changes due to how individuals anticipate future economic conditions. With adaptive expectations, there can be short-term trade-offs between inflation and unemployment. However, under rational expectations, individuals incorporate all available information into their expectations, leading to more immediate adjustments, and the Phillips curve tends to be vertical in the long run, indicating no permanent trade-off.