Using the following data,
Year 1 2 3 4 5
Actual Income 2 1 3 6 7
and believing that permanent income P[t], which is what we believe, in period t, that our sustainable income will be in period t+1, is determined by:
P[t] = 1/2 Y[t] + 1/2 Y[t-1]
(a) Write out P[t] for t = 2 to 5.
(b) How does this model compare with the adaptive expectations model?
(c) How "rational" is the model?