Lesson 4 - Decision Analysis

Question 1

Payoff Table

Answer 1

1. First column - decision alternatives (A1, A2, A3…)
2. Consider the various states of nature
3. For each decision alternative and state of nature, estimate the associated payoff.

Question 2

State of Nature

Answer 2

Anything that can influence the outcome of your decision, and which you cannot control.

Question 3

Optimistic Approach

Answer 3

Seeks to obtain the best payoff that can occur. *No guarantee

Question 4

Conservative Approach

Answer 4

conservative approach evaluates each decision alternative in terms of the worst payoff that can occur. You choose the highest payoff in the worst case scenario.

Question 5

Minimax Regret Approach

Answer 5

Falls between optimistic and conservative approach in terms of risk-taking.

Minimax regret approach evaluates each decision alternative in terms of the minimum of the maximum regret values that can occur.

Question 6

Opportunity Loss

Answer 6

Additional payoff you could have realized if you had made the best decision. ** not an out-of-pocket loss

Question 7

Values in Regret Table

Answer 7

Values in a regret table represent maximum regrets or the maximum opportunity costs.

You would choose the minimum value of the listed regrets.
** always want to minimize your losses

Question 8

What is the key difference between decision makers?

Answer 8

It is their attitude towards risk.

Question 9

Optimistic Decision Maker

Answer 9

Is willing to take risks, so he selects the decision alternative with the highest potential payoff.

Question 10

Conservative Decision Maker

Answer 10

Wishes to minimize risk, he chooses least risky investment/decision alternative.

Question 11

The Middle Decision Maker

Answer 11

Is in middle with his view of risk - he will likely choose minimax regret approach to reach a decision.

Question 12

Decision Making without Probabilities

Answer 12

Making a decision where the probabilities of the states of nature are not known.

3 Different Approaches:

  1. Optimistic Approach
 2. Conservative Approach
 3. Minimax Regret Approach

Question 13

Expected Value Concept

Answer 13

Expected Value of a decision is given by the product of the payoff and the probability of occurrence for each state of nature.

The sum of weighted payoffs for the decision alternative. The weight of the payoff is the probability of the associated state of nature and therefore the probability that the payoff will occur.