Editing Cobweb model (section)

== Role of expectations ==
One reason to be skeptical of this model's predictions is that it assumes producers are extremely shortsighted. Assuming that farmers look back at the most recent prices in order to forecast future prices might seem very reasonable, but this backward-looking forecasting (which is called [[adaptive expectations]]) turns out to be crucial for the model's fluctuations. When farmers expect high prices to continue, they produce too much and therefore end up with low prices, and vice versa.

In the stable case, this may not be an unbelievable outcome, since the farmers' prediction errors (the difference between the price they expect and the price that actually occurs) become smaller every period. In this case, after several periods prices and quantities will come close to the point where supply and demand cross, and predicted prices will be very close to actual prices. But in the unstable case, the farmers' errors get ''larger'' every period. This seems to indicate that [[adaptive expectations]] is a misleading assumption—how could farmers fail to notice that last period's price is ''not'' a good predictor of this period's price?

The fact that [[Agent (economics)|agents]] with adaptive expectations may make ever-increasing errors over time has led many economists to conclude that it is better to assume [[rational expectations]], that is, expectations consistent with the actual structure of the economy. However, the rational expectations assumption is controversial since it may exaggerate agents' understanding of the economy. The cobweb model serves as one of the best examples to illustrate why understanding [[Expectation (epistemic)|expectation]] formation is so important for understanding economic dynamics, and also why expectations are so controversial in recent economic theory.

=== The "Anpassung nach Unten" and "Schraube nach Unten" argument ===
{{Confusing|date=May 2017}}
The German concepts which translate literally "adjustment to lower" and "screw to lower" are known from the works of Hans-Peter Martin and Harald Schumann, the authors of ''[[The Global Trap]]'' (1997). Martin and Schumann see the process to worsened living standards as screw-shaped. Mordecai Ezekiel's ''[[The Cobweb Theorem]]'' (1938) illustrate a screw-shaped expectations-driven process.<ref>Ezekiel, Mordecai: "The Cobweb Theorem". ''The Quarterly Journal of Economics'', vol. 52, No. 2 (Feb. 1938) pp. 255–280.</ref> Eino Haikala has analyzed Ezekiel's work among others, and clarified that time constitutes the axis of the screw-shape.<ref>Haikala, Eino: Maatalouden ominaissuhdanteet ja cobweb-teoria (1956). Pellervo.</ref> Thus Martin and Schumann point out that the cobweb theorem works to worsen standards of living as well. The idea of expectations-variation and thus modeled and induced expectations is shown clearly in Oskar Morgenstern's ''Vollkommene Voraussicht und Wirtschaftliches Gleichgewicht''.<ref>Morgenstern, Oskar: Vollkommene Voraussicht und wirtschaftliches Gleichgewicht. Zeitschrift für Nationalekonomie Bd. 6 (1935) pp. 337–357.</ref> This article shows also that the concept of perfect foresight (vollkommene Voraussicht) is not a Robert E. Lucas or rational expectations invention but rests in [[game theory]], Morgenstern and John von Neumann being the authors of ''[[Theory of Games and Economic Behavior]]'' (1944). This does not mean that the [[rational expectations|rational expectations hypothesis]] (REH) is not game theory or separate from the cobweb theorem, but vice versa. The "there must be" a random component claim by [[Alan A. Walters]] alone shows that rational (consistent) expectations is game theory,<ref>Walters, Alan A.: "Consistent Expectations, Distributed Lags and the Quantity Theory". ''The Economic Journal'' 81 (322) (Feb. 1971) pp. 273–281.</ref> since the component is there to create an illusion of [[random walk]].

Alan A. Walters (1971) also claims that "extrapolators" are "unsophisticated", thus differentiating between [[prediction]] and [[forecasting]]. Using induced modeled expectations is prediction, not forecasting, unless these expectations are based on extrapolation. A prediction does not have to even try to be true. To avoid a prediction to be falsified it has to be, according to Franco Modigliani and Emile Grunberg's article "The Predictability of Social Events", kept private.<ref>Modigliani, Franco & Grunberg, Emile: "The Predictability of Social Events". ''Journal of Political Economy'', Vol. 62, No. 6 (Dec. 1954) pp. 465–478.</ref> Thus public prediction serves private one in REH. Haikala (1956) claims that cobweb theorem is a theorem of deceiving farmers, thus seeing cobweb theorem as a kind of rational or rather, consistent, expectations model with a game-theoretic feature. This makes sense{{According to whom|date=February 2017}} when considering the argument of Hans-Peter Martin and Harald Schumann. The [[Truth value|truth-value]] of a prediction is one measure in differentiating between non-deceiving and deceiving models. In Martin and Schumann's context, a claim that anti-Keynesian policies lead to a greater welfare of the majority of mankind should be analyzed in terms of truth. One way to do this is to investigate past historical data. This is contrary to the principles of REH, where the measure of policies is an economic model,<ref>Kydland, Finn E. & Prescott, Edward: Rules Rather than Discretion: The Inconsistency of Optimal Plans. ''Journal of Political Economy'', Vol. 85, No. 3 (Jun. 1977) pp. 473–492.</ref> not reality, and credibility, not truth. The importance of intellectual climate emphasized in Friedmans' work<ref>Friedman, Milton & Friedman, Rose: Free to Choose.</ref> means that the credibility of a prediction can be increased by manipulating public opinion, despite its lack of truth. Morgenstern (1935) states that when varying expectations, the expectation of future has always to be positive (and prediction has to be credible).

Expectation is a dynamic component in both REH and cobweb theorem, and the question of expectation formation is the key to Hans-Peter Martin's and Harald Schumann's argument, which deals with trading current welfare for expected future welfare with actually worsening policies in the middle. This 'in order to achieve that then we have to do this now' is the key in [[Bertrand de Jouvenel]]'s work. Cobweb theorem and the rational (consistent) expectations hypothesis are part of [[welfare economics]] which according to Martin and Schumann's argument act now to worsen the welfare of the majority of mankind. [[Nicholas Kaldor]]'s work ''The Scourge of Monetarism'' is an analysis of how the policies described by Martin and Schumann came to the United Kingdom.