Decision-Making <ul><li>Generation of feasible alternatives </li></ul><ul><li>Measure of effectiveness by which the most preferred alternative is selected </li></ul><ul><li>Decision Theory provides an analytic and systematic approach for decision-making through various decision models </li></ul><ul><li>Decision Models are classified according to the degree of certainty . </li></ul><ul><li>The scale of un-certainty can range from complete certainty to complete un-certainty </li></ul>
Steps in Decision Theory <ul><li>Listing all possible future events , called the states of nature, which can occur in the context of decision problem </li></ul><ul><li>Identification of all course of actions (alternatives ) which are available to the decision-maker </li></ul><ul><li>Expressing the pay-offs resulting from each pair of course of action and state of nature </li></ul><ul><li>Choosing an appropriate course of action from the given list on the basis of some criterion that results in the optimal (desired) pay-off . </li></ul>
Decision-Making Environment <ul><li>Decision-making under certainty : The Decision-Maker has complete knowledge (perfect information) of consequence of every alternative with certainty .Obviously ,he will select an alternative that yields maximum pay –off for the known state of nature </li></ul><ul><li>Here , certainty means only one possible state of nature (future) </li></ul>
Decision-Making Environment <ul><li>Decision-Making under Risk : </li></ul><ul><li>The decision-maker has less than complete knowledge with certainty of the consequences of every course of action .Here , there are more than one state of nature ( future ) and for which he makes an assumption of the probability with each state of nature . </li></ul>
Decision-Making Environment <ul><li>Decision-Making under Un-certainty : </li></ul><ul><li>The decision-Maker is unable to specify the probabilities with which the various states of nature (futures) will occur . For example : The probability that Mr. X will be the PM of the country 15 years from now is not known . </li></ul>
Example : <ul><li>A food products company is contemplating the introduction of revolutionary new product with new packaging or replace the existing product at much higher price (S 1 ) or moderate change in the composition of the existing product with anew packaging at small increase in price (S 2 ) or a small change in the composition of the existing product except the word ‘New’ with negligible increase in price (S 3 ). The three possible states of nature are : (i) high increase in sales (N 1 ), (ii) No change in sales (N 2 ) and (iii) decrease in sales (N 3 ) .The Marketing Department of the company worked out the pay-offs in terms of yearly net –profits for each of the strategies of three events ( Expected sales ) </li></ul>
Opportunity Loss Table 0 2,00,000 4 ,00,000 1,50,000 0 1,50,000 1,50,000 3,00,000 0 N1 N2 N3 Strategies S1 S2 S3 States Of Nature
Expected Monetary Value (EMV) <ul><li>EMV for a given course of action is the weighted average pay-off , which is sum of the pay-offs for each course of action multiplied by the probabilities associated with each state of nature . </li></ul><ul><li>EMV( alternative , S j ) = Σ p ij .p i for all i </li></ul><ul><li>p i : probability of occurrence of state of </li></ul><ul><li>nature i </li></ul><ul><li>p ij : pay-off associated with the state of nature N i </li></ul><ul><li>and course of action S j </li></ul>
Selecting Strategy Based on EMV <ul><li>Construct a pay-off matrix listing all possible courses of action and stares of nature .Enter the conditional pay-off values associated with each possible combination of course of action and states of nature along with probabilities of the occurrence of each state of nature . </li></ul><ul><li>Calculate the EMV of each course of action by multiplying the conditional pay-offs by the associated probabilities and add these weighted values for each course of action </li></ul><ul><li>Select the course of action that yields the optimal EMV </li></ul>
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