13) Risk and uncertainty in the short-term

Question 1

Minimax regret rule

- What does is find? How do you use it? What kind of decision maker is it suited to?

Answer 1

• Find the decision/action that MINimises the MAXimum regret (profit lost out on) the decision maker will feel depending on the demand level.
• Method: locate highest value at each demand level then looking along each demand level (row or column) subtract the other values at this demand level from the highest value to give the profit lost out on or the “regret” - you now have a ‘regret table’. Identify the maximum regret per action/decision and choose the action with the lowest maximum regret to get your answer.
• Best suited to ‘bad losers’.

Question 2

Maximax rule

- What does is find? What kind of decision maker is it suited to?

Answer 2

• the decision that MAXimises the MAXimum pay-off.
• Suited to optimists.

Question 3

Maximin rule

- What does is find? How do you use it? What kind of decision maker is it suited to?

Answer 3

• the decision that MAXimises the MINimum pay-off.
• Suited to pessimists who want best result if worst happens.

Question 4

Sensitivity analysis on Expected Value decisions

- How do you do it?

Answer 4

Use the EV formual algebraically, rearranging it to find the unknown. E.g. EV = ∑pv , if unknown is the value to which an outcome would have to drop to become unprofitable, at this point EV would be 0. Multiply the equation out with EV set to 0 and the unknown value as x, rearrange to find x. (“x” will have replaced one of the v’s (values))

Question 5

What are risk maps in the TARA framework laid out by?

Answer 5

Probability and impact.

Question 6

What assumption is made about a decision maker when using the expected value method?

Answer 6

They are ‘risk neutral’

Question 7

Expected value formula

Answer 7

EV = ∑pv

Where:

x = future outcome (value)
p = probability of outcome occurring

Question 8

Value of perfect information - Calculate

Answer 8

= value with information (EV only of the profit maximising decision/demand intersections) - value without information (highest EV of all the possible decisions)

Question 9

Using EV with profit pay-off table - to get EV of each decision

Answer 9

Looking along each DECISION row/column, multiply the profit expected at each demand level by the probability of that demand level, sum these at each decision row/column to get the EV of that decision/production level

Question 10

How should you read a decision tree?

Answer 10

Always from right to left

Question 11

What do you need to remember about the Ps (Probablilties) in EV sensitivity analysis questions where you are calculating the level to which one of the probabilities would have to change to in order to reverse a decision?

Answer 11

The total probabilites must always be equal to 1. So if you take the equation, set the EV to 0 and the probability you’re analysing to P, you must also change the other probability to be 1 - P.

Question 12

How do you calculate the coefficient of variation?

Answer 12

= Standard deviation / EV (Expected Value)

*Gives the relative size of the risk rather than just looking at the sta