Decision

theory
 Decision making.

– The process of choosing a course of action for

dealing with a problem

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 How are decisions made?

 Steps in systematic decision making.

– Identify and analyze alternative courses of action from
which the final decision is made
– Identify possible outcomes

– Construct a pay off table

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 Decision Making Environments

 Decision environments include:

– Certain environments.

– Risk environments.

– Uncertain environments.

– Conflict environment

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 Decision under Uncertainty

 Criterion of pessimism (minimax or

maximin)
 Criterion of optimism (maximax or
minmin)
 Laplace or equally likely decision criterion
 Hurwicz criterion or Criterion of realism
 Savage criterion or criterion of regret
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 Decision under Certainty

 Expected monetary value criterion

n
EMV ( A j )   pij Pi
i 1
– Where n = number of stated
Pi = probability of occurrence of that state
pij = pay off for the ith state and jth action

 Expected opportunity loss criterion

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Exercise
A vegetable and fruit retailer sells strawberries which have
very limited useful life. If not sold on the day of
delivery, it is worthless. One case of strawberries costs
Rs.20, and the wholesaler receives Rs.50 for it. The
wholesaler can not specify the number of cases
customers will call for on one day. But her analysis of
past records has produced in table below

Daily sales No. of days sold Probability

10 15 .15
11 20 .20
12 40 .40
13 25 .25
Total 100 1.00 7
 Decision under Certainty

 Marginal analysis
– Expected marginal profit = expected marginal
loss
– p (MP) = (1 – p) (ML)
– Minimum probability required to stock
another unit
– p* = ML/(MP+ML)

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 Decision trees

 An electronic company makes profit of Rs.10000

per day at present. The company has the option to
go in for license from another company and make
a profit of Rs.20000 per day gross but has to pay
a royalty of Rs.6000 per day. It has another
option to go in for research and development at a
cost of Rs.10000. The company makes a profit of
Rs.25000 with probability of 70% success and
30% failure.
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 Decision trees
 Mr. Anish had to decide whether or not to drill a
well on his farm. In his town, only 40% of the
wells were successful at 200ft of depth. Some of
the farmers who did not get water at 200ft, drilled
further up to 250ft but only 20% stuck water at
250ft. Cost of drilling is Rs.50 per foot. Mr.Anish
estimated that he would pay Rs.18000 during a 4
year period in the present value terms, if he
continues to buy water from the neighbour rather
than go for the well which would have a life of 4
years. Mr.Anish has three decisions to make (a)
should drill up to 200ft and (b) if no water found
at 200ft, should he drill up to 250ft? (c) should he
continue to buy water from neighbour? 10