Decision making

Question 1

Payoffs

Answer 1

In order to evaluate each course of action, the decision maker must associate a value or payoff with the result of each event. In business applications, this payoff is usually expressed in terms of profits or costs, although other payoffs such as units of satisfaction or utility are sometimes considered. In the chapter-opening scenario the payoff is the return on investment.

Question 2

Payoff table

Answer 2

A table that shows the values associated with every possible event that can occur for each course of action.

Question 3

Opportunity loss

Answer 3

The opportunity loss is the difference between the highest possible profit for an event and the actual profit for an action taken.

Question 4

Opportunity loss

Answer 4

The opportunity loss is the difference between the highest possible profit for an event and the actual profit for an action taken.

Question 5

Expected monetary value EMV

Answer 5

The sum of payoffs for each event and action multiplied by the respective event probabilities.

Question 6

Expected opportunity loss EOL

Answer 6

The sum of the losses for each event and action multiplied by the respective event probabilities.

Question 7

Link between EMV and EOL

Answer 7

Earlier, you learned how to use the expected monetary value criterion when making a decision. An equivalent criterion, based on opportunity losses, is introduced next. Payoffs and opportunity losses can be viewed as two sides of the same coin. It all depends on whether you wish to view the prob- lem in terms of maximising expected monetary value or minimising expected opportunity loss.

Question 8

EVPI

Answer 8

The expected opportunity loss from the best decision is called the expected value of perfect information (EVPI).

Question 9

Expected profit under certainty

Answer 9

The expected profit under certainty represents the expected profit that you could make if you have perfect information about which event will occur.

Question 10

EVPI =

Answer 10

expected profit under certainty − expected monetary value of the best alternative

Question 11

EPVI explained

Answer 11

This EVPI value of $19.2 million represents the maximum amount that you should be will- ing to pay for perfect information. Of course, you can never have perfect information and you should never pay the entire EVPI for more information. Rather, the EVPI provides a guideline for an upper bound on how much you might consider paying for better informa- tion. The EVPI is also the expected opportunity loss of not marketing the model.

Question 12

Payoff table example

Answer 12

Photos 1-2

Question 13

Decision tree example

Answer 13

Photo 3

Question 14

Opp loss example

Answer 14

Photo 4

Question 15

EMV equation

Answer 15

Photo 5

Question 16

Calculating EMV example

Answer 16

Photos 6-7

Question 17

EOL equation

Answer 17

Photo 8

Question 18

Calculating EOl example

Answer 18

Photo 9

Question 19

EVPI example

Answer 19

Photos 10-11

Question 20

Statistical inference

Answer 20

the theory, methods, and practice of forming judgements about the parameters of a population and the reliability of statistical relationships, typically on the basis of random sampling.