Expectations over time

The impact of time on economic processes is profound but ignored in models which only consider equilibria. The impact ranges from expectations, the formation of habits (reference points), changing preferences, intertemporal dependence of choices, and the development of needs and desires. The future is uncertain, and the probabilities of future events are unknown. Thus, expected values cannot be computed. The economic environment may change, the expected utility (profit) and experienced utility (profit) may differ, and we may develop habits affecting our future behavior. Rational expectations rest on a predictable economic development with stochastic exogenous disturbances but a quick return to equilibrium, a stochastic version of perfect foresight. This is not the economy we live in. Behavioral Economics shows that reference points (established by past behavior or the social environment) affect utilities. Discounting rates of future payments depend on amounts, but large sums are discounted at lower rates, the reverse of "rational discounting." Keynes's effective demand today depends on expectations of future demand and profits affecting current investment decisions. Technology improves with applications--positive feedback--and causes non-ergodic instead of ergodic processes where the outcome is independent of the sequence of events. This distinction is most relevant for evaluating the short-run and long-run outcomes.