Decision Making Under Uncertainty

Daily supply
Probability 40 salads 50 salads 60 salads 70 salads
40 salads 0.10 $80 $0 $(80) $(160)
Daily Demand 50 salads 0.20 $80 $100 $20 $(60)
60 salads 0.40 $80 $100 $120 $40
70 salads 0.30 $80 $100 $120 $140
*Consider this table for the first three numbers.

1. Maximin Criterion (The Pessimistic Point-of-view)

 States that the decision maker should select the course of action whose worst (maximum)
loss is better than the least (minimum) loss of all other courses of action possible in given
circumstances.
 Also called maximin regret or minimax criterion.
 Involves selecting the alternative that maximizes the minimum pay-off achievable.
 For example, so, how many salads will Geoffrey decide to supply? Looking at the payoff
table above,
o If we decide to supply 40 salads, the minimum pay-off is $80.
o If we decide to supply 50 salads, the minimum pay-off is $0.
o If we decide to supply 60 salads, the minimum pay-off is ($80).
o If we decide to supply 70 salads, the minimum pay-off is ($160)
o The highest minimum payoff arises from supplying 40 salads. This ensures that the
worst possible scenario still results in a gain of at least $80.
 The investor would look at the worst possible outcome at each supply level, then selects
the highest one of these. The decision maker therefore chooses the outcome which is
guaranteed to minimize his losses. In the process, he loses out on the opportunity of making
big profits.
 This approach would be appropriate for a pessimist who seeks to achieve the best results
if the worst happens.

2. Maximax Criterion (The Optimistic Point-of-view)

 States that the decision maker should select the course of action whose best (maximum)
gain is better than the best gain of all other courses of action possible in given
circumstances.
 The maximax rule involves selecting the alternative that maximizes the maximum payoff
available.
 This approach would be suitable for an optimist, or 'risk-seeking' investor, who seeks to
achieve the best results if the best happens.
 For example, so, how many salads will Geoffrey decide to supply?
 Looking at the payoff table, the highest maximum possible pay-off is $140. This happens if
we make 70 salads and demand is also 70. Geoffrey should therefore decide to supply 70
salads every day.
 The manager who employs the maximax criterion is assuming that whatever action is
taken, the best will happen; he/she is a risk-taker.
 3. Laplace (The Average Point-of-view)
 All states of nature are equally likely to occur.
 Select alternative with best average payoff. For example, the highest possible payoff is $120
when the demand is 60 salads and we can make 50 salads.
 What would a person somewhere in the middle of the two extremes choose to do? Take
an average of the possible payoffs.
 In other words, use the Laplace criterion (named after mathematician Pierre Laplace). Find
the average payoff for each alternative, then the maximum of those.

4. Regret Criterion (Minimax Regret or Lost Opportunity Point-of-view)

 What would a person choose who wanted to minimize the worst mistake possible?
 The minimax regret strategy is the one that minimizes the maximum regret.
 It is useful for a risk-neutral decision maker. Essentially, this is the technique for a 'sore loser'
who does not wish to make the wrong decision.
 'Regret' in this context is defined as the opportunity loss through having made the wrong
decision.
 To solve this a table showing the size of the regret needs to be constructed. This means we
need to find the biggest pay-off for each demand row, then subtract all other numbers in
this row from the largest number.
 For example, if the demand is 40 salads, we will make a maximum profit of $80 if they all
sell. If we had decided to supply 50 salads, we would achieve a nil profit. The difference
or 'regret' between that nil profit and the maximum of $80 achievable for that row is $80.

Daily supply
40 salads 50 salads 60 salads 70 salads
40 salads $0 $80 $160 $240
Daily Demand 50 salads $20 $0 $80 $160
60 salads $40 $20 $0 $80
70 salads $60 $40 $20 $0

 The maximum regrets for each choice are thus as follows (reading down the columns):
o If we decide to supply 40 salads, the maximum regret is $60.
o If we decide to supply 50 salads, the maximum regret is $80.
o If we decide to supply 60 salads, the maximum regret is $160.
o If we decide to supply 70 salads, the maximum regret is $240.
 A manager employing the minimax regret criterion would want to minimize that maximum
regret, and therefore supply 40 salads only.

5. Hurwitz Criterion (Routh-Hurwitz Stability Criterion)

 States that having one necessary condition and one sufficient condition for stability. If any
control system doesn’t satisfy the necessary condition, then we can say that the control
system is unstable. But, if the control system satisfies the necessary condition, then it may
or may not be stable. So, the sufficient condition is helpful for knowing whether the control
system is stable or not.
 The necessary condition is that the coefficients of the characteristic polynomial should be
positive. This implies that all the roots of the characteristic equation should have negative
real parts.
 Consider the characteristic equation of the order ‘n’ is –
o a0sn+a1sn−1+a2sn−2+...+an−1s1+ans0=0
 Note that, there should not be any term missing in the nth order characteristic equation.
This means that the nth order characteristic equation should not have any coefficient that
is of zero value.
 The sufficient condition is that all the elements of the first column of the Routh array should
have the same sign. This means that all the elements of the first column of the Routh array
should be either positive or negative.
 For example, determine the stability of the system if the equation is:
o a(s)=2s5+3s4+2s3+s2+2s+2
 o Since there are two sign changes in the first column, the characteristic equation has
two roots with negative real parts. Therefore, the system is unstable.

References:
 http://www.businessdictionary.com/definition/maximin-criterion.html
 http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Maximax,%20maximin%20and%
20minimax%20regret.aspx
 https://testmyprep.com/subject/finance-1/laplace-criterion-decision-criteria-under
 https://www.tutorialspoint.com/control_systems/control_systems_stability_analysis.htm
 https://www.javatpoint.com/control-system-routh-hurwitz-stability-criterion