Adaptive Expectations Model:

A  major  drawback  of  the  partial adjustment model  is that  it  assumes  optimal consumption  to be  dependant on current  income alone. An alternative is to assume that since income changes from period  to period  individuals base theif  consumption decisions on permanent or expected  incone v. nich  is estimated as a weighted sum of all past values of income.  In  other words consumers plan  expenditures keeping  in mind  their customary  income  (X_t*),  which is  assessed  by  taking into  account all previous income earned.  This may be modeled as  

with x,*  being estimated using an adaptive expectations mechanism.

'The  adaptive expectations  approach assumes  that expectations  are  updated each period  by  a percentage  of  the  difference between  current  income and previous expected income, For ease of estimation, we rewrite equation as

X_t- 

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