Decission Theory

Question 1

Iconic Model

Answer 1

Physical Replica

Question 2

Analog Model

Answer 2

Physical Model but abstract e.g. Thermometer

Question 3

Mathematical Model

Answer 3

Representation using formulas

Question 4

Systematic Approach to Decission Making

Answer 4

1. Identify the problem
2. Determine possible solutions
3. Determine Criteria used for evaluation
4. Evaluate possible solutions
5. Choose an alternative
6. Implement Alternative
7. Evaluate the result

Question 5

Objective Function

Answer 5

Mathematical expression that describes an objective

Question 6

Capacity constraint

Answer 6

Constraints on the factors of production that can be used

Question 7

Deterministic Model

Answer 7

All uncontrollable inputs are known and cannot vary

Question 8

Stochastic Model

Answer 8

Uncontrollable inputs are uncertain and can varry

Question 9

Probabilistic Model

Answer 9

Uncontrollable inputs are uncertain and can varry

Question 10

Certainty

Answer 10

An event will hapen with a 100% certainty e.g. patent expiration

Question 11

Risk

Answer 11

A probability less than 100% that an event will occur e.g. 58%

Question 12

Uncertainty

Answer 12

A range of probabilities that an event will occur e.g. 10% - 30%

Question 13

Ambiguity

Answer 13

Individuals cant or wontassign a probability or range of probabilities to an event e.g. The Internet being invented

Question 14

Optimistic approach

Answer 14

Maximax approach (Maximum of Maximums)

Question 15

Conservative approach

Answer 15

Minimax approach (Maximum of Minimums)

Question 16

Minimax Regret approach

Answer 16

Select the Alternative with the minimum of the maximum regrets

Question 17

Regret

Answer 17

Maximum Payoff in a state of Nature - Actual Payoff given state of nature and decission taken (sunk costs are irrational)

Question 18

Hurwicz apporach

Answer 18

Maximum of the weighted payoffs using the optimism coefficient

Question 19

Optimisim coeficcient (alpha)

Answer 19

For every possible decission the payoffs are multiplied by the optimizism coeficient (individually assigned) and the maximum of agood_outcome-(1-a)bad_outcome is choosen

Question 20

Bayes-Laplace approach

Answer 20

Assign equal probabilities to all outcomes and find the maximum outcome

Question 21

Expected Value Principle

Answer 21

Multiply expected outcomes by probabilities and choose the maximum return

Question 22

Expected Utility Theory (Gains)

Answer 22

The Gain in Utility decreases as the total amount of money gained increases (The first euro won is better than the second)

Question 23

Expected Utility Theory (Losses)

Answer 23

The Disutility increases as the total amount of euros lost increases (The Second Euro lost hurts more than the first)

Question 24

Axiom

Answer 24

A premise so evident it has to be taken as true

Question 25

4 Von Neumann-Morgenstern Axioms of Expected Utility Theory

Answer 25

An Individual can enter a lottery
The lottery with the highest expected utility will be chosen

1. Completeness: An Individuals has a clear opinion about every lottery (better, worse or indifferent)
2. Transitivity: All individuals will always choose a consistent lottery in accordance to the Completeness Axiom
3. Independence: All decissions of preffered lotteries stay the same if the player is presented with an aditional lottery
4. Continuity: It an individual prefers A to B and B to C than there is is a combination of A and C where the individual is indeffrent between the combination and C

Question 26

Prospect Theory

Answer 26

Descriptive Theory of decission making (how would people actually react?)

Question 27

Expected Utility Theory

Answer 27

Normative theory of decission making (how should people behave?)

Question 28

Fundamental Assumptions of Prospect Theory

Answer 28

1. Choices are evaluated relative to an individual reference point (past wealth, expectations, social environment) the change in money is important not the final stage
2. Individuals are loss averse
3. Individials are risk averse for gains (realizing profits for sure) and risk seeking for losses (try any chance not to loose anything and risk higher losses)
4. Very small probabilities are overweighted and very large probabilities are underweighted