Conventions as a basis for forming expectations, Microeconomics

Conventions as a Basis for Forming Expectations:

Since there is little objective basis for probability distributions about future yields, decision-makers have to act on the basis of subjective judgments. It means there must be some element of arbitrariness involved in the formation of expectations and therefore, in the decisions taken on the basis of those expectations. In such situations individual decision-makers, in forming their expectations, usually tend to fall back on practical norms or conventions generally prevailing in society. 

For example, one convention for estimating the expected rate of return on an investment project may be as follows: Assume that an objective probability distribution for future returns on an investment project can be determined from quantitative historical data. Hence, estimate regression equations which have the rate of return on such projects as the dependent variable and particular subsets of a set of variables as independent variables. Then, on the basis of some given statistical criterion (convention) choose the 'best' estimated regression equation. Use this, given values of the independent variables, to obtain an estimated probability distribution for the rate of return on the investment project. 

The tendency to rely on conventional wisdom might be due to a variety of reasons. Individuals might feel that conventions reflect the collective wisdom of others who have been in similar positions and therefore would be less arbitrary as a guide to decision-making. Besides, individual decision-makers can justify their decisions as being of the same variety as that taken by many others placed in similar position. In this, case it appears less the outcome of individual whim or sentiment or prejudice.

Moreover, in following conventions, particularly in relation to the valuation of investments or assets, the individual entrepreneur might be minimising risks. If a majority of investors follow the same conventions in calculating values then the individual entrepreneur would have a good idea about the market value of his investment over the short tern. Once the investment has been made on the basis of such valuation, the entrepreneur will be exposed to the risk of a significant loss. Since individuals have relatively greater certainty about the near future, the chance of increasing losses over a short time period is small.

Posted Date: 11/19/2012 7:42:51 AM | Location : United States







Related Discussions:- Conventions as a basis for forming expectations, Assignment Help, Ask Question on Conventions as a basis for forming expectations, Get Answer, Expert's Help, Conventions as a basis for forming expectations Discussions

Write discussion on Conventions as a basis for forming expectations
Your posts are moderated
Related Questions
draw demand curve for a-phone explain how the graph, price ,and quantity demand will change if there is an overall increase in income.

what is fixed and variable inputs with more explanation

Suppose that the price of schooling is $20 per year of schooling and it suddenly rises to $40. Compute the point price elasticity of demand at the initial price level and at the fi

Define the adoption of economic institutional arrangement in analytical frameworks. Adoption of Economic Institutional Arrangement: The third step for studying an economi

waht are the characteristics of perfect competetion market


2 i) Explain what are the key assumptions by the welfarist approach. ii) Define and discuss the properties of a Generalized Utilitarian social welfare function and represent it

Explain how the price system eliminates a surplus. The meaning of surplus is that quantity demanded is less as compared to the quantity supplied.  This will lead to downward pr

Capital Gain: A capital gain is a form of profit which is earned on an investment by re-selling an asset for more than it cost to buy. Assets that can be purchased for this purpose