Rational expectations and the Cournot-Theocharis problem

• Main Author: Tönu Puu
• Format: Article
• Language: English
• Published: Hindawi Limited 2006-01-01
• Series: Discrete Dynamics in Nature and Society
• Online Access: http://dx.doi.org/10.1155/DDNS/2006/32103

In dynamic models in economics, often “rational expectations” are assumed. These are meant to show that the agents can correctly foresee the result of their own and the other agents' actions. In this paper, it is shown that this cannot happen in a simple oligopoly model with a linear demand function and constant marginal costs. “Naive expectations,” that is, where each agent assumes the other agents to retain their previous period action, are shown to result in a 2-period cycle. However, adapting to the observed periodicity always doubles the actual resulting periodicity. In general, it is impossible for the agents to learn any periodicity except the trivial case of a fixed point. This makes the whole idea of “rational expectations” untenable in Cournot oligopoly models.