Conventions as a basis for forming expectations, Microeconomics

Assignment Help:

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.


Related Discussions:- Conventions as a basis for forming expectations

What is the concept of the development, What is the concept of the developm...

What is the concept of the development? The concept of the development: Development is a complicated multi-dimensional concept to do along with enhancements in the human

What is the equilibrium quantity?, Supply and demand for a given type of MP...

Supply and demand for a given type of MP3 player are given by the following equations: P=980-1.5Qd P=20+0.9Qs

Explain the term laissez-faire, Explain the term Laissez-Faire The term...

Explain the term Laissez-Faire The term "laissez-faire" is used to explain an economic system where the government intervene as little as possible and leave the private sector

Public goods and public choice, politicians are often heard saying that tui...

politicians are often heard saying that tuition at state universities should be kept low to make equation equally accessible to all residents of the state, regardless of income

Microeconomic theory, Homer consumes only donuts and beer. When he consumes...

Homer consumes only donuts and beer. When he consumes less than 10 beers, Homer would gladly drink one more. After drinking 10 beers, Homer is so drunk that he does not notice any

Expenditure trends and pattern, Expenditure Trends and Pattern: Total ...

Expenditure Trends and Pattern: Total expenditure of the Centre has risen twice as fast as total revenue, although much of this reflects rising interest payments. Revenue expe

Estimating and predicting cost, Estimating and Predicting Cost * Estima...

Estimating and Predicting Cost * Estimates of future costs can be obtained from a cost function, which relates cost of production to level of output and other variables which t

Calculate the output per dollar wage and unit labor cost, Using the Wage Ra...

Using the Wage Rate and Output per Hour as indicated on the table below, calculate the output per dollar wage and unit labor cost. Then decide on the optimal wage rate for this c

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd