Explain the concept of adaptive expectations in the context of the Phillips Curve.

Explain the concept of adaptive expectations in the context of the Phillips Curve.

Adaptive expectations refer to the idea that individuals form their expectations about future inflation based on their past experiences. In the context of the Phillips Curve, adaptive expectations imply that workers and firms adjust their wage and price-setting behavior based on their perception of past inflation rates.

For example, if workers expect a higher rate of inflation based on their recent experience, they will demand higher wage increases to compensate for the expected rise in prices. Similarly, firms will anticipate higher costs and adjust their pricing accordingly.

This concept suggests that there is a lag in the adjustment of expectations to changes in the economy. As a result, the Phillips Curve may shift over time as individuals update their expectations based on new information. If inflation turns out to be higher or lower than expected, it can lead to a shift in the short-run Phillips Curve.