Specifically, how they form their expectations on future employment, income, and prices. Milton Friedman had a theory on this subject which he dubbed adaptive expectations. Adaptive expectations states that people will ponder past economic performance and simply react to the previous economic period in the next one. He believed that individuals took a trial and error sort of approach to economic behavior that is based solely past performance. This was the predominant thinking in economics for many years until the new classical idea of rational expectations evolved.
Rational expectations say that people are intelligent instead of just plain reactionary.
That they will use not only there past experiences but any, and all, available relevant information to try and most accurately predict future economic behavior. Coupling there past experiences with informed guesses about the future people will form rational expectations of what s to come, economically. Rather than trail and error, this theory suggests an informed precautionary approach to economic decision making by individuals. Although introducing more method than previous theories, rational expectations is an intangible, unidentifiable, and all but completely random variable, which economists attempt to guess, into the economics equation. That leads us to the Lucas critique, which is simply an observation.