ECS3705
ASSIGNMENT 3
SEMESTER 2
OCT/NOV 2026
UNIQUE NO:
DUE DATE: 19 OCTOBER 2026
, ECS3705 – HISTORY OF ECONOMIC THOUGHT
ASSESSMENT 3 S2 OCT/NOV 2026 FINAL EXAM
QUESTION 1 [20]
(a) Keynes, Friedman and Lucas: expectations in macroeconomic theory [15]
Paragraph 1 – Keynes
Keynes treated expectations as an important but inherently uncertain influence on
economic behaviour. In his view, households and firms make decisions about
consumption, investment and employment on the basis of expectations concerning
future income, profits, interest rates and economic conditions. Because the future
cannot be known with certainty, expectations are influenced by confidence, conventions
and current circumstances rather than being formed through a precise calculation of all
available information. This means that changes in expectations can affect aggregate
demand and employment even before actual economic conditions change. For
example, pessimistic expectations about future profits can cause firms to reduce
investment, lowering aggregate demand and employment. Keynes therefore gave
expectations an important role in explaining economic fluctuations and the possibility
that an economy could remain below full employment.
Paragraph 2 – Friedman
Friedman moved macroeconomic theory towards the idea of adaptive expectations.
Individuals were assumed to form expectations about future inflation partly by learning
from past inflation. Thus, if actual inflation persistently differed from what people
expected, they would gradually revise their expectations. Friedman used this reasoning
particularly in his criticism of the long-run Phillips curve trade-off. He argued that
attempts by governments to maintain unemployment below its natural rate through
expansionary monetary policy would eventually lead workers and firms to adjust their
inflation expectations. Once expectations had adapted, unemployment would return
ASSIGNMENT 3
SEMESTER 2
OCT/NOV 2026
UNIQUE NO:
DUE DATE: 19 OCTOBER 2026
, ECS3705 – HISTORY OF ECONOMIC THOUGHT
ASSESSMENT 3 S2 OCT/NOV 2026 FINAL EXAM
QUESTION 1 [20]
(a) Keynes, Friedman and Lucas: expectations in macroeconomic theory [15]
Paragraph 1 – Keynes
Keynes treated expectations as an important but inherently uncertain influence on
economic behaviour. In his view, households and firms make decisions about
consumption, investment and employment on the basis of expectations concerning
future income, profits, interest rates and economic conditions. Because the future
cannot be known with certainty, expectations are influenced by confidence, conventions
and current circumstances rather than being formed through a precise calculation of all
available information. This means that changes in expectations can affect aggregate
demand and employment even before actual economic conditions change. For
example, pessimistic expectations about future profits can cause firms to reduce
investment, lowering aggregate demand and employment. Keynes therefore gave
expectations an important role in explaining economic fluctuations and the possibility
that an economy could remain below full employment.
Paragraph 2 – Friedman
Friedman moved macroeconomic theory towards the idea of adaptive expectations.
Individuals were assumed to form expectations about future inflation partly by learning
from past inflation. Thus, if actual inflation persistently differed from what people
expected, they would gradually revise their expectations. Friedman used this reasoning
particularly in his criticism of the long-run Phillips curve trade-off. He argued that
attempts by governments to maintain unemployment below its natural rate through
expansionary monetary policy would eventually lead workers and firms to adjust their
inflation expectations. Once expectations had adapted, unemployment would return
