Perfect Foresight

You step into Madame Sybil's House of Augurs and ask her about your future. She looks into her crystal ball. Suddenly, she's in a trance. She sees...she sees...long hours sitting around in pajama pants, eating the crumbs from the bottom of a Doritos bags and watching the Love Actually director's cut on a constant loop.

At first, you're skeptical. Leaving her parlor, you scoff. You figure it's all a scam. Then comes the weekend. At some point, as you brush Dorito detritus from your pajama pants and tear up at the extended version of the doorway cue-card scene, you realize...it all came true.
Madame Sybil saw the future!

That's perfect foresight. The complete, accurate knowledge of what's going to happen. Obviously, it’s not something many people have. Madame Sybil might have the gift. Or maybe (probably) she just took one look at you and made an educated guess. Generally speaking, however, perfect foresight...doesn't exist. Need evidence? Just go to a race track. Or the stock market.

But the idea of perfect foresight plays a role in some economic discussions. Economics, in real life, is complicated. To look at the total economy of a big country, like the United States, you're really looking at the day-to-day individual decisions of hundreds of millions of people. We're talking billions of small transactions, each one a complicated tangle of motivations and incentives.

Modeling that kind of thing with 100% accuracy is impossible. So to make any type of predictions about the future, economists have to make assumptions. They just have to...simplify. (Hello, Thoreau.)

Enter perfect foresight. It describes the ideal situation for an economic actor. A person with perfect foresight knows exactly what will happen when they make an economic decision: buy a car, invest in a stock, purchase the softest, most durable pajama pants they can find. Because they have perfect foresight, they will always do the thing that benefits them the most.

Making this assumption allows economists to at least determine how certain scenarios should unfold. It allows them to model economic behavior. Think of how a physicist can predict what will happen if you drop a penny off a tall building. They can take into account the distance it's falling, the gravitational constants, and stuff like air resistance. From that, they can tell you with certainty whether the penny is going to kill someone on the street if it hits them in the head.

That physicist has perfect foresight of the movement of that penny. Unfortunately, econ doesn't play out like physics. Economics deals with the decisions of people. And people are...weird.

So, as a result, econ involves all sorts of uncertainties and psychology and other quirks that make it much harder to model than a penny falling from the sky. In practice, perfect insight doesn't come into play. For most economic models, a slightly less strict assumption is made: rational expectations.

Instead of assuming people have perfect knowledge of the future, the theory of rational expectations proposes that people act on their most reasonable guesses about the future. The expectations are based on things like the current situation and their experience about what's happened in the past.

Apply this model to your trip to Madame Sybil. She didn't need perfect insight. A rational expectation about your weekend leads to the same conclusion.

Madame Sybil can take one look at you and reasonably predict that Doritos and couch potato time are in your future. Doesn't exactly take a Nostradamus to put two and two together.