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Decision Under Uncertainty

This document discusses decision-making under uncertainty and various methods used to make decisions when outcomes are unknown. It describes situations of uncertainty where multiple outcomes are possible from a decision. It then explains five criteria for decision-making under uncertainty: Maximin, Maximax, Regret, Hurwicz, and Laplace. Each criterion takes a different approach to selecting the optimal decision when faced with uncertainty regarding outcomes.

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89 views14 pages

Decision Under Uncertainty

This document discusses decision-making under uncertainty and various methods used to make decisions when outcomes are unknown. It describes situations of uncertainty where multiple outcomes are possible from a decision. It then explains five criteria for decision-making under uncertainty: Maximin, Maximax, Regret, Hurwicz, and Laplace. Each criterion takes a different approach to selecting the optimal decision when faced with uncertainty regarding outcomes.

Uploaded by

Prince Pierre
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Decision-Making

Under
Uncertainty
FOR STUDENTS IN MANRECO
1ST SEMESTER AY 2019-2020
Decision-making under
Uncertainty
 A decision problem where a decision-maker is aware of
various possible states of nature but has insufficient
information to assign any probabilities of occurrence to
them.
 There are many unknowns and no possibility of knowing
what could occur in the future to alter the outcome of a
decision
 A situation of uncertainty arises when there can be more
than one possible consequences of selecting any courses of
actions.
Examples of decision-making
under uncertainty
 Launching a new product
 A major change in marketing strategy
 Opening your first branch
All these could be influenced by such factors as the reaction of
competitors, new competitors, technological changes, change in
customer demand, economic shifts, government legislation and
a host of conditions beyond your control.
Methods of DMU

1) Maximin Criterion
2) Maximax Criterion
3) Regret Criterion
4) Hurwicz Criterion
5) Laplace Criterion
Maximin Criterion

 Known as the criterion of pessimism


 Used when the decision-maker is pessimistic about future.
 Maximin implies the maximization of minimum payoff
 The pessimistic decision-maker locates the minimum payoff
for each possible courses of action
 The maximum of these minimum payoffs is identified and
the corresponding courses of action is selected.
Example
 A decision-maker has 3 possible alternatives, A1, A2, and
A3; where the outcomes of each of them can be affected by
the occurrence of any one of the four (4) possible events,
S1, S2, S3, and S4. The monetary payoffs of each
combination of A1 and S1 are given in the table:

Events Min. Max.


S1 S2 S3 S4 Payoff Payoff
Actions

A1 27 12 14 26 12 27
A2 45 17 35 20 17 45
A3 52 36 29 15 15 52
Solution

 Since 17 is maximum out of the minimum payoffs, the


optimal action is A2.
Maximax Criterion

 Known as the criterion of optimism.


 Used when the decision-maker is optimistic about future.
 Maximax implies the maximization of maximum payoff
 The decision-maker locates the maximum payoff for each
possible course of action
 The maximum of these payoffs is identified and the
corresponding course of action is selected
Solution

 A3 is the optimal action for Maximax Criterion


Regret Criterion

 Focuses upon the regret that the decision-maker might have


from selecting a particular course of action
 Regret is the difference between the best pay-off (one could
have realized, had it been known that the state of nature was
going to occur) and the realized payoff.
 This difference which measures the magnitude of the loss
incurred by not selecting the best alternative, is also known
as opportunity loss or opportunity cost
Solution
Events Max
S1 S2 S3 S4 Regret
Actions

A1 25 24 21 0 25
A2 7 19 0 6 19
A3 0 0 6 11 11

From the maximum regret column, we find that the


regret corresponding to the course of action is A3 is
minimum. Hence, A3 is optimal.
Hurwicz Criterion

 The decision-maker is either optimistic or pessimistic.


 The degree of or index of optimism or pessimism of the
decision-maker is taken into account
 If a, a constant lying between 0 and 1, denotes the degree of
optimism, then the degree of pessimism will be 1-a. Then a
weighted average of the maximum and minimum payoffs of
an action, with a and 1-a as respective weights, is
computed.
 The action with highest average is regarded as optimal.
Hurwicz Criterion
 It is noted that a nearer to unity indicates that the decision-
maker is optimistic, while a value nearer to zero indicates
that he is pessimistic.
 As an example, let us apply this criterion to the payoff
matrix of example 17. Assume that the index of optimism a
= 0.7.
Action Max.Payoff Min.Payoff Weighted Average
A1 27 12 27 x 0.7 +12 x 0.3 = 22.5
A2 45 17 45 x 0.7 + 17 x 0.3 = 36.6
A3 52 15 52 x 0.7 + 15 x 0.3 = 40.9
Since the average for A3 is maximum, it is optimal.
Laplace Criterion

 In the absence of any knowledge about the probabilities of


occurrence of various states of nature, one possible way out
is to assume that all of them are equally likely to occur.
 If there are n states of nature, each can be assigned a
probability of occurrence = 1/n. Using these probabilities,
we compute the expected payoff for each course of action.
And the course of action with maximum expected value is
regarded as optimal.
 States of nature are the possible future events that are likely
to occur.

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