DS-OS06 (1) (1) Avinash

DECISION
THEORY
Group- OS_06
1 Avinash Deshmukh (06)

2 Omkar Patil (24)
3 Aniket Sutar (31)
4 Anshu Thakur (34)
5 Hritik Ugar (36)
INTRODUCTION
● Decision-making is a constant human experience, from mundane choices to

life-altering ones. Decision science steps in to equip us with tools and
techniques to navigate these choices more effectively.
● These techniques leverage the power of mathematics and statistics to extract

knowledge from data.
● Quantitative analysis involves collecting measurable data, like past customer

demographics or website traffic patterns. Statistical models can then
analyze this data to identify trends and predict the potential reach of the
campaign.
Types of decision :
● Decision under certainty.

● Decision under risk.
● Decision under uncertainty.
Methods for Decision under Uncertainty:
● Optimistic criterion:
● Pessimistic criterion:
● Minimax Regret criterion:
Importance
Decision theory
01 02 03
Reduced Bias and Objectivity: Enhanced Comparison: Predictive Power:
Numbers and data provide a By using standardized metrics and Statistical models are adept at
neutral foundation for analysis. models, quantitative analysis identifying patterns in historical
This helps to minimize the allows you to compare different data. These patterns can then be
influence of subjectivity and options on an equal footing. This used to forecast future outcomes
personal biases that can cloud our is crucial when evaluating. associated with different choices
judgment.
Improved Efficiency: Decision Theory Risk Management:
Quantitative techniques can Decision theory provides

automate many aspects of techniques for assessing and
data analysis, saving Stronger Communication
managing risk, allowing
significant time and decision-makers to make
resources. This frees up informed choices in situations
decision-makers to focus on where outcomes are uncertain
interpreting the results and The data-driven nature of or where there are potential
making strategic choices quantitative analysis makes it losses involved.
easier to communicate the
rationale behind a decision.
Problem to solve with Qualitative
Technique
Explain the solution for the below problem based on different

decisions criteria. Mr. Sethi has Rs. 10000 to invest in one of
the three options A, B and C. The return on his investment
depends on whether the economy experiences inflation,
recession or no change at all. His possible returns under each
condition are given below
Identified Quantitative Technique used
Expected Monetary Value (EMV) is a concept used in

project risk management to quantify the potential impact of
EXPECTED MONETARY
uncertain events on project objectives, particularly

concerning project costs and revenues .
VALUE
EMV allows project managers to assess the potential outcomes of

various risk scenarios and make informed decisions based on
probabilities and expected financial values.
This involves calculating the Expected Monetary Value (EMV) to

make decisions when outcomes are uncertain
Problem : Explain the solution for the below problem based on different decisions criteria. Mr. Sethi has
Rs. 10000 to invest in one of the three options A, B and C. The return on his investment depends on
whether the economy experiences inflation, recession or no change at all. His possible returns under
each condition are given below
Justify your technique:

Decision under risk and uncertainty (EMV) is justified for this problem because it allows Mr. Sethi to evaluate the
potential outcomes of each investment option based on the probabilities of different states of nature (inflation,
recession, or no change). By calculating the EMV for each option, Mr. Sethi can make an informed decision that
maximizes his expected returns while considering the associated risks.
Decision under Risk and Uncertainty (EMV) Analysis:
For each Strategy (A, B, C), calculate the Expected Monetary Value (EMV) under each state of nature (Inflation,
Recession, No Change).
Laplace criterion:
strategy Inflation Recessio No Expected Max.
n change Payoff Payoff
A 2000 1200 1500 1566.667 -
B 3000 800 1000 1600 -
c 2500 1000 1800 1766.66 1766.66
● Expected payoff= 1/n(P1+P2+P3….Pn)

● We don’t consider Laplace Criterion because market is not stable all the time.
Sethi will not with this situation this situation because of market instability.
1. Maximax(optimistic) criterion:
Strategy Inflation Recession No change Max. Payoff
A 2000 1200 1500 2000
B 3000 800 1000 3000
C 2500 1000 1800 2500
•This criterion assumes that the decision-maker is optimistic and seeks to maximize the maximum possible payoff.
Strategy B has the highest maximum payoff of 3000, indicating the potential for the highest return if the best-case
scenario occurs in each state of nature.
It's suitable for decision-makers who are risk-tolerant and prioritize maximizing potential gains over minimizing
losses.
 Strategy B has the highest maximum payoff of 3000, indicating the potential for the highest return if the best-case
scenario occurs in each state of nature.
 It's suitable for decision-makers who are risk-tolerant and prioritize maximizing potential gains over minimizing
losses.
2. Maximin (Pessimistic) Criteria:
•This criterion is based on pessimism, aiming to maximize the minimum possible payoff.
Strategy Inflation Recessio No Min. Maximum
n change payoff among
minimum
A 2000 1200 1500 1200 1200
B 3000 800 1000 800 -
C 2500 1000 1800 1000 -
•Strategy A has the highest minimum payoff of 1200, indicating the strategy with the least risk, ensuring a
minimum return even in the worst-case scenario.
•It's appropriate for risk-averse decision-makers who prioritize ensuring a minimum acceptable outcome.
c. Minimax Regret Criteria:
•This criterion focuses on minimizing the maximum regret, which is the difference between the maximum
possible payoff and the actual payoff under each state of nature.
Minimax
Regret/Savage
Strategy Inflation Recession No Change Criterion
A 1000 0 300 1000
B 0 400 800 800
C 500 200 0 500
 Strategy C has the minimum maximum regret of 500, indicating that even in the worst-case scenario, the
regret associated with this strategy is the lowest compared to the other strategies.
 It's useful for decision-makers who are concerned about potential regrets and aim to minimize the impact of
unfavourable outcomes.
d. Expected Monetary Value (EMV) Criteria:
•This criterion calculates the expected payoff for each strategy by considering the probabilities of different states
of nature.
Strategy EMV
A 1566.67
B 1600
C 1766.67
-Strategy C has the highest expected payoff of 1766.67, indicating that, on average, it offers the highest return
considering the likelihood of each economic condition.
-It's suitable for decision-makers who want to make choices based on rational calculations of expected outcomes,
considering both potential gains and probabilities.
Based on the different decision criteria:
•Maximax: Strategy B (3000)

•Maximin: Strategy A (1200)
•Minimax Regret: Strategy C (500)
•Expected Monetary Value (EMV): Strategy C (1766.67)
Conclusion:
•If Mr. Sethi is highly optimistic and seeks to maximize potential gains without much concern for potential losses,
Strategy B would be suitable for him.
•If he is risk-averse and prioritizes ensuring a minimum acceptable outcome even in the worst-case scenario,
Strategy A would be the best choice.
•If he wants to minimize potential regrets associated with his decision, Strategy C would still be the optimal
choice.
•However, if he aims to make a decision based on rational calculations of expected outcomes, considering both
potential gains and probabilities, Strategy A would offer the highest expected payoff.

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DECISION

1 Avinash Deshmukh (06)

● Decision-making is a constant human experience, from mundane choices to

● These techniques leverage the power of mathematics and statistics to extract

● Quantitative analysis involves collecting measurable data, like past customer

● Decision under certainty.

Quantitative techniques can Decision theory provides

Explain the solution for the below problem based on different

Expected Monetary Value (EMV) is a concept used in

uncertain events on project objectives, particularly

EMV allows project managers to assess the potential outcomes of

This involves calculating the Expected Monetary Value (EMV) to

Justify your technique:

B 3000 800 1000 1600 -

c 2500 1000 1800 1766.66 1766.66

● Expected payoff= 1/n(P1+P2+P3….Pn)

Strategy Inflation Recession No change Max. Payoff

A 2000 1200 1500 2000

B 3000 800 1000 3000

C 2500 1000 1800 2500

B 3000 800 1000 800 -

C 2500 1000 1800 1000 -

A 1000 0 300 1000

B 0 400 800 800

C 500 200 0 500

•Maximax: Strategy B (3000)

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