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Expectations

16 December, 2015 - 15:14

In our natural gas example, if households expected that the price of natural gas was going to stay low for many years – perhaps on account of the discovery of large deposits – then they would be tempted to purchase a gas burning furnace rather than an oil burning furnace, particularly if they anticipated that the price of oil would increase. In this example, it is more than the current price that determines choices; the prices that are expected to prevail in the future also determine current demand.

Expectations are particularly important in stock markets. When investors anticipate that corporations will earn high rewards in the future they will buy a stock today. If enough people believe this, the price of the stock will be driven upward on the market, even before profitable earnings are registered.