Modern economic depends largely on probability. Economicobservations and analysis can be approached through random eventsthat can be evaluated through probability methods. The paper willdiscuss the meaning of probability, when it is used, and threemethods of assigning probabilities.
Whento Use Probability
Quantitative analysis of uncertainty is often challenging. You cannotanalyze what you do not know. Information and uncertain informationcan be tackled using probability which is the mathematics ofuncertainty. Probability theory has been developed to help inunderstanding in practical decision making.
ThreeMethods of Assigning Probabilities
In classical method of assigning probability, two assumptions aremade. The first assumption assumes that the total number of outcomesare known in advance. The second assumes that all the outcomes areequally likely to occur. For instance, if you have n number ofcommodity, the classical probability of each commodity is 1/n (Galavotti,2015). The method even if it has well developedmathematical grounds it is not used in reality as the assumptions arenot satisfied.
The formula that canbe used in classical probability is
The form of assigning probability is usually the ratio of a singleevent occurring and the sum of a number of events. It used after datais collected, where a single data is compared to the total of all thedata collected. The total of the frequency should add up to 100%. Forinstance, when a coin is tossed, probability of having a head is ½while that of having a tail is also ½. The Relative-frequency of theoccurrence both head and tail is 100%, while the total occurrence ofa head is 50 % while that of the tail is 50% too.
From the two methods above of presenting probability, it can bededuced that theoretical method compares the value of an event withthat of a total number of events. Relative-frequency gives the ratioor the percentage value of an outcome. In addition, inrelative-frequency, the total occurrence should sum up to 100% whichis not the case in classical comparison.
Subjective probability is based on individual`s personal judgment ifan event will occur or not. The method requires no formal calculationand requires opinion and application of experience to judge theevents. The method differs from one person to the other as people arebiased and have different opinions concerning events. The method alsorequires the high flexibility of opinions (Galavotti,2015).
For instance, in a match between two teams, team A and team B, thesubjective of either of the teams winning will differ depending onpeople’s opinion and past performances of the teams. The methoddoes not make predictions to be facts.
The method differs with the others as it does not involvemathematical calculation or use of numerical. The method has highchances of having errors, unlike classical and relative-frequencymethods which follow a mathematical procedure.
In conclusion, chances of an event occurring bring controversy andthe only tool that can be used to work it out are probability. Tocalculate the likelihood of an event one can use classical method,relative-frequency method or use the subjective method. Classical andrelative-frequency methods are more accurate and reliable as theyinvolve mathematical calculations, but the subjective method is proneto errors since is an imaginary method.
Galavotti,M. C. (2015). ProbabilityTheories and Organization Science The Nature and
Usefulnessof Different Ways of Treating Uncertainty. Journalof Management, 41(2),744-760.