DECISION MAKING UNDER UNCERTAINTY

ACC-104: MANAGEMENT SCIENCE o For making decisions under uncertainty, there are different criteria
LESSON 1:
1. MAXIMAX (also called optimistic criteria)
2ND SEMESTER | A.Y. 202Y – 202Y o Maximize the maximum payoff
LECTURER: MS./SIR o Maximum of maximum payoffs
o The decision maker finds the maximum possible payoff for each alternatives and then chooses the alternative
DECISION MAKING 4) List the Payoffs – depending on what alternatives with maximum payoff within the group of maximum
we choose or what state-of-nature exists
Decision Analysis Alternatives Favorable Economy Unfavorable Economy Maximax (max.)
Large Plant $200,000 - $180,000 $200,0000
Steps Alternatives Favorable Unfavorable Small Plant $100,000 - $20,000 $100,000
Large Plant $200,000 - $180,000 Do Not Build 0 0 0
1) Clearly Define the Problem
Small Plant $100,000 - $20,000
2) List Down Your Alternatives
Do Not Build 0 0 o Out of the 3, the maximum is P200,000 – that means if we are using Maximax criteria, the decision is to go
─ Strategies
with large plant because that will result in maximum profit
─ You have control over them (or controllable)
─ The alternatives should always be Decision Making Environment CONCLUSION: He will choose to build a large plant because that is the best thing that could ever happen.
exhaustive/complete (considering all
elements) CERTAINTY
─ Alternatives are not necessarily 2, it can be 4 2. MAXIMIN (also called pessimistic criteria)
and you choose the best and the worst  We know for sure what will be the outcome o Maximize the minimum payoff
─ It always depend on the problem  Example: o Maximum of minimum payoffs
3) Identify the Outcomes or State-of-the-Nature P1,000 – Savings = 1% o The decision maker finds the minimum possible payoff for each alternatives and then chooses the alternative
─ Conditions – Deposit CD = 2% with maximum payoff within the group of minimum
─ You have no control over them (or – None = 0%
Alternatives Favorable Economy Unfavorable Economy Maximin (min.)
uncontrollable)
P10,000 – Savings = 1% (P10,000 + 100) Large Plant $200,000 - $180,000 - $180,000
4) Construct a Payoff Table
– Treasury Bills = 4% (P10,000 + 400) Small Plant $100,000 - $20,000 - $20,000
─ List the payoffs
Do Not Build 0 0 0
─ This is depending on what alternatives we
choose or what state-of-nature exists  For each situations, outcome is certain and
predictable. When you deposit in a savings o Out of the 3, 0 is the minimum payoff – If we are going to use Maximin criteria, the decision is to do not
5) Select One of the Decision Theory Model (or Math
account, you know how much money you are build a plant
Model)
─ Certainty, Uncertainty, or Risk going to make as every bank has their own
CONCLUSION: He will choose not to build a plant because that is the best thing that could ever happen.
6) Apply the Model and Make Decisions interest rates.

3. CRITERION OF REALISM (also called Hurwicz)

UNCERTAINITY o It is a compromise between the maximax and the minimax decision criteria.
Example:
o In this criteria, there is a coefficient called alpha ( – Greek alphabet)
1) Define the Problem  Probabilities are not known (unpredictable)
o = coefficient of realism
 If you put your money in a stock market in a
company, the price of that company may go up or o 0≤ ≤1; = 0 (maximin)
Thompson Lumber Company wants to expand in
which they want to create more products that can down. = 1 (maximax)
reach different customers  It is very unpredictable and there are a lot of o Weighted Average (WA) = (maximum payoff) + (1 – ) (minimum payoff)
uncertainties
2) List the Alternatives  We make decisions under uncertainty Alternatives Favorable Economy Unfavorable Economy Realism (α = 0.8)
o Large Plant Large Plant $200,000 - $180,000 $124,000
o Small Plant Small Plant $100,000 - $20,000 $76,000
o Do Not Build RISK Do Not Build 0 0 $0

NOTE: Do Not Build is the optimal/best  Probabilities are known = 0.8

 predictable but uncertain
3) Identify the Outcomes or State-of-the-Nature Large Plant WA (L) = (best) + 1 – (worst)
 Example 1: Rolling of a dice = it has 6 sides and
the probability is 1/6 = 0.8 (200,000) + 0.2 (-180,000)
o Favorable – there will be a lot of demand and  Example 2: Drawing of one card = it turns out to = 160,000 – 36,000
company will be able to sell more of the be an Ace and the probability is 4/52 (because = $ 124,000 – what he will earn on average if he builds a large plant
products there are 4 aces in a pack of cards and there are
o Unfavorable – the demand will not be that 42 cards in all) Small Plant WA (S) = (best) + 1 – (worst)
strong = 0.8 (100,000) + 0.2 (-20,000)
= 80,000 – 4,000
= $ 76,000 – what he will earn on average if he builds a small plant

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 = 0 – 20,000
Do Not Build WA (DB) = (best) + 1 – (worst) = -$ 20,000 – what he will earn on average if he builds a small plant
= 0.8 (0) + 0.2 (0)
= $ 0 – what he would earn on average if he did not build a plant Do Not Build WA (DB) = (best) + 1 – (worst)
= 0 (0) + 1 (0)
= $ 0 – what he would earn on average if he did not build a plant
CONCLUSION: He will choose to build a large plant because that is the highest weighted payoff and is the
best thing that could ever happen. OPTIMISTIC DECISION MAKER (because 80%, which is more than 50%,
was multiplied to the best payoff, while only 20% was multiplied to the worst payoff.) CONCLUSION: He will choose to not build a plant because that is the highest weighted payoff and is the
best thing that could ever happen. PESSIMISTIC DECISION MAKER (because 0 was multiplied to the best
=1 payoff, while 100% to the worst payoff.)
Large Plant WA (L) = (best) + 1 – (worst)
4. EQUALLY LIKELY
= 1 (200,000) + 0 (-180,000)
o We assume that whether it will be favorable market or unfavorable market, we assume that both are 50-50
= 200,000 – 0
= $ 200,000 – what he will earn on average if he builds a large plant Alternatives Favorable Economy Unfavorable Economy Equally Likely
Large Plant $200,000 - $180,000 $10,000
Small Plant WA (S) = (best) + 1 – (worst) Small Plant $100,000 - $20,000 $40,000
= 1 (100,000) + 0 (-20,000) Do Not Build 0 0 0
= 100,000 – 0
= $ 100,000 – what he will earn on average if he builds a small plant
o = 0.5
Do Not Build WA (DB) = (best) + 1 – (worst) Large Plant WA (L) = (best) + 1 – (worst)
= 1 (0) + 0 (0) = 0.5 (200,000) + 0.5 (-180,000)
= $ 0 – what he would earn on average if he did not build a plant = 100,000 – 90,000
= $10,000 – what he will earn on average if he builds a large plant

CONCLUSION: He will choose to build a large plant because that is the highest weighted payoff and is the Small Plant WA (S) = (best) + 1 – (worst)
best thing that could ever happen. OPTIMISTIC DECISION MAKER (because 100% was multiplied to the best
= 0.5 (100,000) + 0.5 (-20,000)
payoff and 0 to the worst payoff.)
= 50.000 – 10,000
= $ 40,000 – what he will earn on average if he builds a small plant
= 0.2
Large Plant WA (L) = (best) + 1 – (worst) Do Not Build WA (DB) = (best) + 1 – (worst)
= 0.2 (200,000) + 0.8 (-180,000) = 0.5 (0) + 0.5 (0)
= 40,000 – 144,000 = $ 0 – what he would earn on average if he did not build a plant
= -$104,000 – what he will earn on average if he builds a large plant

Small Plant WA (S) = (best) + 1 – (worst) CONCLUSION: He will choose to build a small plant.
= 0.2 (100,000) + 0.8 (-20,000)
= 20,000 – 16,000 5. MINIMAX REGRET
= $ 4,000 – what he will earn on average if he builds a small plant o Minimizing maximum opportunity loss
o Minimum of maximum payoffs
Do Not Build WA (DB) = (best) + 1 – (worst) o The decision maker might experience regret after the decision has been made and states of nature
(conditions) have occurred. Thus, the decision maker tries to minimize this regret prior to the selection of a
= 0.2 (0) + 0.8 (0)
particular alternative.
= $ 0 – what he would earn on average if he did not build a plant
o Subtract the maximum value to the payoff
o Regret Figure = Size of Regret (Loss)
CONCLUSION: He will choose to build a small plant because that is the highest weighted payoff and is the o The size of regret is according the best thing could ever happen
best thing that could ever happen. PESSIMISTIC DECISION MAKER (because only 20% was multiplied to o In regret figure, there is no negative number
the best payoff, while 80% was multiplied to the worst payoff.) o Get the minimum because that is the minimum regret figure you can get

=0
1st Example
Large Plant WA (L) = (best) + 1 – (worst)
= 0 (200,000) + 1 (-180,000) Alternatives Favorable Economy Unfavorable Economy Minimax Regret
= 0 – 180,000 Large Plant $200,000 - $180,000 $180,000
= -$180,000 – what he will earn on average if he builds a large plant Small Plant $100,000 - $20,000 $100,000
Do Not Build 0 0 $200,000
Small Plant WA (S) = (best) + 1 – (worst)
Alternatives Favorable Economy Unfavorable Economy Minimax Regret
= 0 (100,000) + 1 (-20,000) Large Plant ($200,000 - $200,000) (0 – (-$180,000) $180,000

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 0 $180,000 CONCLUSION: The minimum of the 3 is 100,000 because it is the least regret figure, so he will choose to
Small Plant ($200,000 - $100,000) (0 – (-$20,000) $100,000 build a small plant.
$100,000 $20,000
Do Not Build ($200,000 - 0) (0 - 0) $200,000
$200,000 0 4th Example

Favorable Economy You ride a jeep wearing earrings ($50,000), with laptop ($100,000), and cellphone ($15,000). However, you
didn’t know that there was a robber inside the jeep you rode.
 Large Plant = The best payoff is $200,000, and it turns out that when he built a large plant, he got
$200,000, so he has no regret at all Alternatives Without a Robber With a Robber Minimax Regret
 Small Plant = He chose to build a small plant and it turns out to be a favorable economy so he got Earrings - $50,000 $35,000
Laptop - $100,000 $85,000
$100,000. However, $200,000 is the best payoff, so he regrets $100,000
Cellphone - $15,000 $0
 Do Not Build = He chose not to build a plant. It turns out that the economy is favorable, so he regrets
$200,000 since that is the best thing that ever happen.
Alternatives Without a Robber With a Robber Minimax Regret
Unfavorable Economy Earrings - ($15,000 - $50,000) $35,000
$35,000
 Large Plant = The best thing that could have ever happen is not to build to lose nothing. However, since Laptop - ($15,000 - $100,000) $85,000
he opt build a large plant and turns out to be unfavorable economy, he regrets $180,000 (180,000 is $85,000
the regret size, in which he shouldn’t have built a plant) Cellphone - ($15,000 – $15,000) $0
 Small Plant = He chose to build a small plant. However, the economy turns out to be unfavorable not 0
knowing that he would lose $20,000, so he regrets $20,000
 Do Not Build = He chose to not build a plant and it turns out that the economy is unfavorable, he has
With a Robber
no regret at all, since he did not loss anything and it is the best thing to do.
 Earrings = 35,000 is the size of regret, since compared to the best thing (15,000), it is the regret figure
if ever laptop has been robbed
CONCLUSION: The minimum of the 3 is 100,000 because it is the least regret figure, so he will choose to
 Laptop = 85,000 is the size of regret, since compared to the best thing (15,000), it is the regret figure
build a small plant.
if ever laptop has been robbed
 Cellphone = No regret at all, since 15,000 is the least cost out of the 3 and the best thing could ever
happen.
2nd Example

Alternatives Favorable Economy Unfavorable Economy Minimax Regret CONCLUSION: The minimum of the 3 is 0, since 15,000 is the least regret figure out of the 3 and the best
Large Plant $200,000 - $180,000 $185,000 thing could ever happen.
Small Plant $100,000 - $20,000 $100,000
Do Not Build 0 $5,000 $200,000
5th Example
Alternatives Favorable Economy Unfavorable Economy Minimax Regret
Susan Solomon will build a gas station.
Large Plant ($200,000 - $200,000) (5,000 – (-$180,000) $185,000
0 $185,000 Alternatives Strong Fair Poor
Small Plant ($200,000 - $100,000) (5,000 – (-$20,000) $100,000 Large Station $550,000 $110,000 -$310,000
$100,000 $25,000 Medium-Sized Station $300,000 $129,000 -$100,000
Do Not Build ($200,000 - 0) (5,000 - 5,000) $200,000 Small Station $200,000 $100,000 -$32,000
$200,000 0 No Gas Station 0 0 0

CONCLUSION: The minimum of the 3 is 100,000 because it is the least regret figure, so he will choose to Alternatives Strong Fair Poor Minimax
build a small plant. Regret
Large Station ($550,000 - $550,000) ($129,000 - $110,000) (0 – (-$310,000) $310,000
0 $19,000 $310,000
3rd Example Medium-Sized Station ($550,000 - $300,000) ($129,000 - $129,000) (0 – (-$100,000) $250,000
$250,000 0 $100,000
Alternatives Favorable Economy Unfavorable Economy Minimax Regret
Small Station ($550,000 - $200,000) ($129,000 - $100,000) (0 – (-$32,000) $350,000
Large Plant $200,000 - $180,000 $175,000
$350,000 $29,000 $32,000
Small Plant $100,000 - $20,000 $100,000
No Gas Station ($550,000 - 0) ($129,000 - 0) (0 – 0) $550,000
Do Not Build 0 - $5,000 $200,000 $550,000 $129,000 0

Alternatives Favorable Economy Unfavorable Economy Minimax (max.)

Large Plant ($200,000 - $200,000) (-5,000 – (-$180,000) $175,000 Strong Market
0 $175,000
Small Plant ($200,000 - $100,000) (-5,000 – (-$20,000) $100,000  Large Station = Susan chose to build a large station. The market turns out to be strong so she will gain
$100,000 $15,000 $550,000. Since the best payoff is $550,000 as well, she has no regret at all.
Do Not Build ($200,000 - 0) (-5,000 – (-5,000) $200,000  Medium-Sized Station = Susan chose to build a medium-sized station. The market turns out to be strong
$200,000 0
so she will gain $300,000. Since the best payoff is $550,000, she regrets $250,000.

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  Small Station = Susan chose to build a small station. The market turns out to be strong so she will gain In the upcoming season, Farmer McCoy has 4 options. Use Minimax Regret to arrive at the course of action for
$200,000. Since the best payoff is $550,000, she regrets $350,000. Farmer McCoy.
 No Gas Station = Susan chose not to build a gas station. Since the best payoff is $550,000, she regrets
$550,000. Alternatives Heavy Rainfall Moderate Rainfall Light Rainfall Drought
Plant Corn -$20,000 $60,000 -$5,000
Fair Market Plant Wheat $40,000 $50,000 0
Plant Soybean -$50,000 $100,000 -$10,000
 Large Station = Susan chose to build a large station. The market turns out to be fair so she will gain Use The Land For Grazing $12,000 $15,000 $10,000
$110,000. Since the best payoff is $129,000, she regrets $19,000.
 Medium-Sized Station = Susan chose to build a medium-sized station. The market turns out to be fair Alternatives Heavy Rainfall Moderate Rainfall Light Rainfall Drought Minimax
so she will gain $300,000. Since the best payoff is $129,000 as well, she has no regret at all. Regret
 Small Station = Susan chose to build a small station. The market turns out to be strong so she will gain Plant Corn $60,000 $40,000 $15,000 $15,000 $60,000
$100,000. Since the best payoff is $129,000, she regrets $29,000. Plant Wheat 0 $50,000 0 $10,000 $50,000
 No Gas Station = Susan chose not to build a gas station. Since the best payoff is $129,000, she regrets Plant Soybean $90,000 0 $20,000 $20,000 $90,000
$129,000. Use The Land For Grazing $28,000 $85,000 $30,000 0 $85,000

Poor Market
CONCLUSION: The minimum of the 4 is $50,000, since it is the least regret figure out of the 4 and the best thing could
 Large Station = Susan chose to build a large station. The market turns out to be poor so she will lose - ever happen. So Farmer McCoy will choose to plant wheat for the upcoming season.
$310,000. Since the best payoff is 0 or not to build a gas station, she regrets $310,000.
 Medium-Sized Station = Susan chose to build a medium-sized station. The market turns out to be poor
so she will lose -$100,000. Since the best payoff is 0 or not to build a gas station, she regrets $100,000.
 Small Station = Susan chose to build a small station. The market turns out to be poor so she will lose -
$32,000. Since the best payoff is 0 or not to build a gas station, she regrets $32,000.
 No Gas Station = Susan chose not to build a gas station. The market turns out to be poor so she will
lose nothing. Since the best payoff is 0 or not to build a gas station, she has no regrets at all.

CONCLUSION: The minimum of the 4 is $250,000, since it is the least regret figure out of the 4 and the best
thing could ever happen. So Susan Solomon will choose to build a medium-sized gas station.

= 0.7
Large Station WA (L) = (best) + 1 – (worst)
= 0.7 (550,000) + 0.3 (-310,000)
= 385,000 – 93,000
= $ 292,000 – what she will earn on average if she builds a large station

Medium-Sized WA (M) = (best) + 1 – (worst)

Station = 0.7 (300,000) + 0.3 (-100,000)
= 210,000 – 30,000
= $ 180,000 – what she will earn on average if she builds a medium-
sized station

Small Station WA (S) = (best) + 1 – (worst)

= 0.7 (200,000) + 0.3 (-32,000)
= 140,000 – 96,000
= $ 44,000 – what she will earn on average if she builds a small station

No Gas Station WA (NG) = (best) + 1 – (worst)

= 0.7 (0) + 0.3 (0)
= $ 0 – what she would earn on average if he did not build a gas station

CONCLUSION: She will choose to build a large station because that is the highest weighted payoff and is
the best thing that could ever happen. OPTIMISTIC DECISION MAKER (because 70% was multiplied to the
best payoff, while only 30% to the worst payoff.)

6th Example

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