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Decision Theory Part 1

At the end of this topic, students should be able to: 1) Define decision theory and understand the steps of decision making; 2) Differentiate between decision making environments such as under certainty, uncertainty, and risk; 3) Solve problems related to decision making under risk using models like expected monetary value (EMV), expected opportunity loss (EOL), and expected value of perfect information (EVPI).

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Izzati Atirah
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11 views13 pages

Decision Theory Part 1

At the end of this topic, students should be able to: 1) Define decision theory and understand the steps of decision making; 2) Differentiate between decision making environments such as under certainty, uncertainty, and risk; 3) Solve problems related to decision making under risk using models like expected monetary value (EMV), expected opportunity loss (EOL), and expected value of perfect information (EVPI).

Uploaded by

Izzati Atirah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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DECISION THEORY

CHAPTER 2 – PART 1
At the end of  Define decision theory
this topic  Understand the step of decision theory

students  Differentiate type of decision making environment

should be able  Solve problem relate to decision under risk

to:
 Decision theory is an analytic and
systematic approach to the study of
decision making.
• A good decision is based on

DECISION logic, considers all available


data & possible alternatives, &
ANALYSIS? applies the quantitative
approach.

• A bad decision is one that is not


based on logic, doesn’t use all
available info doesn’t consider
all alternatives & doesn’t
employ appropriate quantitative
techniques
1.Clearly define the problem at hand
2. List the possible alternatives
Steps in 3. Identify the possible outcomes or states of nature
Decision 4.List the payoff or profit of each combination of alternatives
Making and outcomes
5.Select one of the mathematical decision theory models
6.Apply the model and make your decision
Decision making under certainty
Decision maker knows with certainty the consequences of every
Decision alternative or decision choice.

Making Decision making under uncertainty .


The decision maker does not know the probabilities of the various
Environment outcomes.
s Decision making under risk.
The decision maker knows the probabilities of the various
outcomes.
Decision  Construction of payoff tables
making  Expected monetary value, EMV

under risk  Expected Opportunity Loss, EOL

 Expected Value of Perfect Information, EVPI


Component of
payoff table
Example 1
1. EMV is the weighted sum of possible payoffs for each alternative.

2. EOL is the cost of not picking the best solution.


Under Risk 3. EVPI places an upper bound on what to pay for information.
1. EMV
2. EOL
3. EVPI
Example 2
Example 3
Part 2
DECISION TREE
End of this
class student  Understand decision making process
should be able  Make decisions based on under risk environment
to:

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