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    Decision Under Uncertainty PDF

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    John Louie Nunez
    Decision making involves choosing between alternatives while considering uncertainty. There are three states of uncertainty: certainty when outcomes are known; risk when outcomes are unknown but probabilities can be estimated; and uncertainty when neither outcomes nor probabilities are known. Tools for decision making under uncertainty include payoff matrices, which quantify outcomes of alternatives, and decision trees, which show how decisions and events relate. Maximin, maximax, and expected value strategies provide different approaches based on a decision maker's attitude toward risk.

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    Decision Under Uncertainty PDF

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    John Louie Nunez
    65 views2 pages
    Decision making involves choosing between alternatives while considering uncertainty. There are three states of uncertainty: certainty when outcomes are known; risk when outcomes are unknown but probabilities can be estimated; and uncertainty when neither outcomes nor probabilities are known. Tools for decision making under uncertainty include payoff matrices, which quantify outcomes of alternatives, and decision trees, which show how decisions and events relate. Maximin, maximax, and expected value strategies provide different approaches based on a decision maker's attitude toward risk.

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    Decision making involves choosing between alternatives while considering uncertainty. There are three states of uncertainty: certainty when outcomes are known; risk when outcomes are unknown but probabilities can be estimated; and uncertainty when neither outcomes nor probabilities are known. Tools for decision making under uncertainty include payoff matrices, which quantify outcomes of alternatives, and decision trees, which show how decisions and events relate. Maximin, maximax, and expected value strategies provide different approaches based on a decision maker's attitude toward risk.

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    65 views2 pages

    Decision Under Uncertainty PDF

    Uploaded by

    John Louie Nunez
    Decision making involves choosing between alternatives while considering uncertainty. There are three states of uncertainty: certainty when outcomes are known; risk when outcomes are unknown but probabilities can be estimated; and uncertainty when neither outcomes nor probabilities are known. Tools for decision making under uncertainty include payoff matrices, which quantify outcomes of alternatives, and decision trees, which show how decisions and events relate. Maximin, maximax, and expected value strategies provide different approaches based on a decision maker's attitude toward risk.

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    Decisions Under Uncertainty

    Decision making is the process of making choices by


    identifying a decision, gathering information, and assessing Decision Strategies Under Uncertainty
    alternative resolutions.
    Payoff Matrix is an essential tool of decision-making. It is a
    Different States of Nature or Decision Environments nice way of summarizing the interactions of various alternative
    action and events. Thus, we can say that a payoff matrix
    1. Certainty – the decision-maker has complete and perfect provides the decision maker with quantitative measures of the
    knowledge regarding impact of all the available alternatives. payoff for each possible consequence and for each alternative
    -- outcomes and its probabilities are known under consideration.
    Ex. Purchasing food at a food booth.
    Utilities expenses will be billed monthly. Example: Payoff Matrix for Plant Crop Problem
    State of Weather
    2. Risk – the decision-maker has incomplete and imperfect Action Good Normal Bad
    knowledge but still able to assign probability estimates to the Plant A 150,000 90,000 (20,000)*
    possible outcomes of a decision. Plant B 130,000 100,000 (10,000)*
    -- outcomes are unknown but probabilities are known Plant C 80,000 50,000 (5,000)*
    Ex. *Loss
    An investor is willing to take to realize a gain from an 1. Maximin/Minimax – the decision-maker is pessimist
    investment. He knows that the probable effect on his - chooses the best of the worst
    investment will either gain, stays the same or subject to loss - maximizes the minimum payoff
    but he doesn’t know what will happen to the entity where he - minimizing the maximum loss
    invests to affect his investment. Ex. The farmer will choose Plant C.

    3. Uncertainty – the decision-maker doesn’t have even the 2. Maximax – the decision-maker is optimist
    information to make probability estimates to the possible - chooses the best of the best
    outcomes of a decision. - maximizing the maximum gain
    -- both outcomes and probabilities are unknown - particulary venturesome (extreme risk-takers)
    Ex. Ex. The farmer will choose Plant A.
    A buyer put in a buy order on a particular stock at X price.
    You don’t know that the stock will fall far enough for the order 3. Expected Value – the decision maker considers all the
    to execute. The outcome is uncertain, the buyer doesn’t know possible outcomes of each alternative. Probability of
    if the order will either expire or it will execute. occurrence of each alternative will now be included.

     The difference of the three can be drawn on the basis of the EVa = ∑ Xaj (Pj)
    degree of knowledge or information possessed by the
    decision-maker. Where:
    Xaj = outcome of act a when state j occurs
     Frank Knight was the one who first drew a distinction Pj = probability of occurrence of state j
    between risk and uncertainty. Ex.
    State of Weather
     Risk and Uncertainty both imply a lack of certainty. Action Good Normal Bad
    P 0.2 0.6 0.2
    Two Approaches to Estimate the Probabilities of Decision Plant A 150,000 90,000 (20,000)*
    Outcomes Plant B 130,000 100,000 (10,000)*
    Plant C 80,000 50,000 (5,000)*
    1. A Priori Measurement – derive probability estimates *Loss
    without carrying out any real world experiment or analysis.
    Ex. Tossing a coin and rolling a die EV (Plant A) = 150,000 (0.2) + 90,000 (0.6) – 20,000 (0.2)
    = 80,000
    A company XYZ’s stock seems like it’s on a hot streak based EV (Plant B) = 130,000 (0.2) + 100,000 (0.6) – 10,000 (0.2)
    on the several days of trading history, so investors give the = 84,000
    stock a 66% chance of increasing again tomorrow. However, a EV (Plant C) = 80,000 (0.2) + 50,000 (0.6) – 5,000 (0.2)
    priori probability, the company can only do one of the three = 45,000
    things – go up, go down or stays the same. Accordingly, there
    is only a 33% chance that the stock will go up tomorrow. In using the expected value criterion, the alternative with the
    highest expected value should be chosen. Hence, the farmer will
    2. A Posteriori Measurement – derive probability estimates choose Plant B.
    based on the assumption that past is a true representative
    (guide to) of the future. 4. Decision Tree – is a schematic representation of the manner
    – Based on statistical analysis in which a particular decision’s consequences are related to
    of data alternative decisions and to uncertain possible events.
    Ex.
    Suppose that there are three acres of land with labels A, B
    and C. One acre has reserves of oil below its surface, while the
    other two do not. A drilling test is conducted on acre B, and the
    results indicate that no oil is present at the location. With acre
    B eliminated, the posterior probability of acre A & C
    containing oil becomes 50%.
    Example:
    Clark Coffee operates a chain of five luxury coffee shops. It is looking at two options to increase revenues across the chain.
    The estimated impact of the two options on sales (and their probabilities) are shown below as the associated costs of each option. The
    table below shows the summary of the owner’s possible decisions.

    Launch Loyalty Card Cut Prices


    Cost of Option Php 500,000 Php 300,000
    Probability of High Sales 0.6 0.8
    Probability of Low Sales 0.4 0.2
    Result of High Sales Php 1,000,000 800,000
    Result of Low Sales Php 750,000 500,000

    Represents decision to make

    Represents uncertain outcomes

    Find the Expected Value and Net Gain:

    Launch Loyalty Card = 1,000,000 (0.6) + 750,000 (0.4)


    = Php 900,000
    Net Gain: 900,000 – 500,000 = Php 400,000

    Cut Prices = 800,000 (0.8) + 500,000 (0.2)


    = Php 740,000
    Net Gain: 740,000 – 300,000 = Php 440,000

    Although Launching Loyalty Card has greater expected value, it has lesser net gain. Therefore, the decision-maker will choose
    option “Cut Prices” because it has greater net gain.

    http://www.statisticshowto.com/posterior-distribution-
    Group 4 (Fourth Reporter) probability/
    AGRIPA, KRIZZIA ANGELLI
    ALEMANIA, PAMELA ANN https://investinganswers.com/financial-
    CAO, CHARLENE dictionary/economics/economic-risk-2918
    ESTALLO, SHINETTE
    NUÑEZ, JOHN LOUIE S. https://www.economicshelp.org/blog/4941/economics/eco
    ROVIRA, ELLAINE GRACE
    nomic-uncertainty/
    SERRANO, ROSHELLE
    TAMPO-OG, MJ
    http://www.businessmanagementideas.com/decision-
    (BSA – 1A)
    making/decision-making-under-certainty-risk-and-
    uncertainty/3371
    Sources:
    www.umassd.edu/fycm/decisionmaking/process/&ved=2ah https://www.productionmachining.com/articles/deal-
    UKEwjh9LvEi_XcAhXHc94KHSS2CmwQFjAFegQICxAQ&usg=A differently-with-certainty-risk-and-uncertainty
    OvVaw3SPPwYzWqCwXcmCrxmPzB2

    https://investinganswers.com/financial-
    dictionary/investing/priori-probability-4657

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