Decision Theory Decision theory problems are characterized by the following: 1.A list of alternatives. 2.A list of possible future states of nature. 3.Payoffs associated with each alternative/state of nature combination. 4.An assessment of the degree of certainty of possible future events. 5.A decision criterion.

Table General Format of a Decision Table

Decision Making under Complete Uncertainty Approaches to decision making under complete uncertainty: 1.Maximin 2.Maximax. 3.Minimax regret. 4.Hurwicz 5.Equal likelihood

Table 11–11Summary of Methods for Decision Making under Complete Uncertainty

The Hurwicz (Realism) Criterion (Weighted Average or Realism Criterion) The approach offers the decision maker a compromise between the maximax and the maximin criteria. –Requires the decision maker to specify a degree of optimism, in the form of a coefficient of optimism α, with possible values of α ranging from 0 to –The closer the selected value of α is to 1.00, the more optimistic the decision maker is, and the closer the value of α is to 0, the more pessimistic the decision maker is.

Decision Making under Risk Decision making under partial uncertainty –Distinguished by the present of probabilities for the occurrence of the various states of nature under partial uncertainty. –The term risk is often used in conjunction with partial uncertainty. Sources of probabilities –Subjective estimates –Expert opinions –Historical frequencies

Approaches to Incorporating Probabilities in the Decision Making Process Expected Monetary Value (EMV) approach –Provides the decision maker with a value that represents an average payoff for each alternative. Expected Opportunity Loss (EOL) –The opportunity losses for each alternative are weighted by the probabilities of their respective states of nature to compute a long-run average opportunity loss, and the alternative with the smallest expected loss is selected as the best choice. Expected Value of Perfect Information (EVPI) –A measure of the difference between the certain payoff that could be realized under a condition of certainty and the expected payoff under a condition involving risk.

Figure Decision Tree Format Decision trees are used by decision makers to obtain a visual portrayal of decision alternatives and their possible consequences.