Chapter 13: Risk and Uncertainty in the short-term Flashcards
Is risk quantifiable or unquantifiable?
Quantifiable (outcomes have associated probabilities)
Is uncertainty quantifiable or unquantifiable?
Unquantifiable (outcomes cannot be mathematically modelled)
What is an expected value?
Summarises all the different possible outcomes by calculating a single weighted average. It is the long run average (mean)
How do we calculate the EV (Expected Value)?
Σpx (p=probability of the outcome occurring, x=the future outcome)
What do pay off tables show?
Profits that can be made from different possible outcomes. There are two factors to consider - demand and supply.
Table shows the different profits from each different contribution of demand and supply.
Probabilities are used on these different profit levels to calculate profits.
What are the advantages of using expected values?
Takes risk into account
Easier decisions
Simple
What are the disadvantages of using expected value?
Little meaning for a one-off project
Ignores attitudes to risk
The answer may not exist
What does someone that is risk averse aim for?
Best possible outcome in the worst case scenario. Maximin.
What does someone who is risk neutral ignore and aim for?
The range of outcomes and aim for the highest EV. Expected Value.
What does someone who is a risk seeker aim for?
Best possible outcome in the best case scenario. Maximax.
How do you calculate Maximin?
Determine the minimum payoff under each supply level.
Choose the supply level with the maximum of those values.
How do you calculate maximax?
Determine the maximum payoff under each supply level.
Choose the supply level with the maximum of those values.
What does a person who is risk averse and a sore loser aim for?
Aim to minimise the regret from making a bad decision. Minimax regret
How do you calculate minimax regret?
Find maximum the payoff in each demand row.
Compare the actual payoff with ‘what we could have earned’
Create a regret table with the values in
Determine the maximum regret for each supply level
Choose the supply level which gives the minimum of those values
How do we calculate standard deviation?
Compares all the actual outcomes with the expected value. It then calculates how far on average the outcomes deviate from the mean.